Listen, if we all had enough money for everything we needed to do – well, that would be pretty great, actually. But since that’s not the case, sometimes you need a loan in order to achieve something important. Maybe it’s consolidating your debt, marrying the love of your life, or just paying back the hospital after the birth of your baby.
But you can’t just accept the first lender who comes along.
Before you start borrowing willy-nilly, it’s important to understand the difference between a personal loan and a line of credit, because each one has different ramifications on your finances. Once you know which is which, you can begin the process of narrowing down your options based on which one will be best for your unique situation.
The difference between a personal loan and a line of credit
Before we begin, below is a table summarizing the main differences between personal loans and lines of credit.
Structure Repayment Interest
Personal loan One-time, lump sum of money Repay in even installments Fixed, predictable interest
Line of credit Use what you need, up to a limit Repay as you borrow Interest can vary based on rate and amount borrowed
When borrowing money, there are two main types of loans: installment loans and revolving loans. A personal loan is a type of installment loan. These kinds of loans give you all of your borrowed money at once in a lump-sum; then you repay it over time in even installments. You know upfront how much interest you will pay, and you’ll also know how much your monthly payments, or installments, will be.
The other type of loan is called a revolving loan. Think of this one as a revolving door, letting you repeatedly take money out and pay it back, take it out and pay it back. A credit card is one type of revolving loan because you can borrow whatever amount you want up to the limit, and then you pay it back.
A line of credit is a revolving loan, and you can think of a credit card as a line of credit as well – Visa, Mastercard, or whoever your issuer is has extended you a line of credit which you can use as you wish. It’s up to you to repay it in a timely fashion.
Personal loans basics
- Fixed payments – You’ll usually have regular monthly payments.
- Predictable interest – You know how much you pay in interest every month.
- Lump-sum – You get all the borrowed funds at once, upfront.
- Pay over time – In exchange for your signature, you get a long time to repay – up to several years or more.
- Use for big purchases – You can use the money for almost anything; such as vehicles, home remodeling, even college education.
- Fees. You may have to pay origination fees, which could be almost 10% of the principal amount borrowed.
Line of credit basics
- Borrow up to your limit – You can borrow less than your limit, too.
- Pay before you borrow again – If you’ve maxed your limit, you must repay what you’ve borrowed before you can borrow more.
- Unpredictable payments – They depend on your rate and how much you’ve taken out at the time of calculation.
- Variable interest – Your interest rate could be variable, tied to an index rate, and subject to change.
- Fees – You could owe fees on top of principal and interest.
Why you should use personal loans
So when should you use personal loans?
You have a big purchase to make
If you’re stuck and wondering how you’ll be able to pay for a big, unusual, or uncommon expense, you may need a personal loan. Personal loans are often used to pay for:
- Home remodel and repair.
- Student debt or even college tuition.
- Wedding, divorce, or a funeral.
- Vehicle refinance.
- Credit card refinance.
You like predictable payments
It can be a big boost to your finances if you know what your monthly payments are because it lets you plan ahead and live by a budget. If you’re going to be borrowing money and want to know exactly what your payment will be every month, go with a personal loan.
You’re trying to get out of debt
Seems like weird advice: borrow money to get out of debt. But in specific instances, it can help. That’s because you may be able to get a lower interest rate on a fixed personal loan than you can on your credit card or other debt. In that case, you may find it useful to consolidate your debts with a personal loan, then focus all your efforts on that one debt.
You want to keep your finance costs down
Speaking of lower interest rates: if you know you need to borrow, you can keep your costs down by choosing the lowest interest rate you can qualify for. That may mean paying for the purchase with a personal loan instead of a credit card because the credit card’s interest rate is higher.
If you’re curious what kind of a rate you can get on a personal loan, try checking out a site like Fiona. After answering a few questions, Fiona will show you a range of lenders and their interest rates.
They work with dozens of lenders, so finding a good fit shouldn’t be a problem. And it doesn’t cost anything to use Fiona – except just a few minutes of your time.
Who should use personal loans
If any of the below sound like you, you may want to consider a personal loan.
You aren’t in a position to save it up
If you aren’t in a position to pay for a purchase in cash, usually you should wait. It’s better to save up the funds than borrow and owe interest. But sometimes you really can’t.
Maybe your roof is leaking, or you finally qualify for better loan terms and need to refinance your car loan to avoid overpaying interest. In those cases, a personal loan can help.
You know exactly what you’re using the money for
It’s a bad idea to take out a personal loan just so you have some spending money in your pocket. That’s a really expensive way to get in over your head. It’s better to go into it knowing exactly what you intend to use the money on — for example, a much-needed bathroom renovation.
You have a plan for paying it back
Perhaps it goes without saying, but you should have a solid plan for repaying the loan. Know whether loan payments will fit into your budget, and how much you can afford. Sometimes personal loans can be helpful because they spread a large cost out over a long period of time, giving you time to repay it.
For example, if you take a look at Monevo, which is a financial service matching site, you can see which lenders will work with you for the loan term you need. With over 30 lender options, loan amounts ranging from $1,000-$100,000, and interest rates between 2.49% - 35.99% APR, you can find a host of options for any budget. Plus, it takes just 60 seconds to see your options!
Why you should use a line of credit
Personal loans are not your only option when you need to borrow. A line of credit is also a useful option.
You may have heard of a home equity line of credit, or HELOC. This is a line of credit that specifically relates to the equity you have in your home. But it’s not the only kind of a line of credit that’s available to people. You can also get a line of credit that’s not tied to your house – such as a credit card.
A credit card line of credit gives you borrowing power without locking you into a specific amount. You can borrow any amount up to your credit limit, then pay it back. It’s a good choice when you need more flexibility than you can get with a personal loan.
You’re not sure how much you’ll need
Use a line of credit when you’re not sure exactly how much you’ll need to borrow. The problem with borrowing more than you need is that you still have to pay interest on the excess. With a line of credit, you only pay interest on the amount you borrow – not the entire credit line (unless you do wind up using it all).
You’re not sure when you’ll need to borrow
With a personal loan, the clock starts ticking on repayment as soon as you receive the funds. That’s fine if you’re using the money immediately. But in some cases, you might not actually need the money for a few weeks or months, and it would hurt your wallet to start paying interest on borrowed money before you’ve even used it.
With a line of credit, you can delay paying on what you borrow until you actually borrow it.
Flexibility is important
A line of credit may be the right choice for you if you need flexibility more than you need low rates or fixed payments. Lines of credits may have higher interest rates than other forms of borrowing, but that could be worth it to you for the higher dollar limit that may be available.
Be sure to pay attention to the “draw period,” which is the time frame during which you borrow against the credit limit, and the “repayment period,” which is when you’ll be expected to pay back the balance. While a personal loan allows you to pay it back in installments, a line of credit doesn’t work that way.
Who should use a line of credit
Now that you have a better grasp on the basics of lines of credit, let’s talk about who should use them.
You own your own home
Home equity lines of credit are well-known for a reason: they give homeowners a way to tap into the equity buried in their homes. A line of credit gives them a way to use that equity – the value in their home above what they owe on their mortgage – immediately, without needing to sell the house to get the cash. Then they can use that credit to further improve the home, pay for schooling, or even cover medical bills.
You’ve got big expenses on the horizon
Lines of credit work well when you know you have a significantly big expense coming up – much larger than your existing credit card limit or bank account balance – but you don’t have a solid dollar amount.
For example, say you’re remodeling your house. You know you’re going to be doling out cash at regular intervals to contractors and the like. Or you’re planning your dream wedding, and you know you’ll have to pay florists and other vendors, but you’re not sure when, how much, or how often.
You’re looking for a little extra “insurance”
Lines of credit and personal loans are two ways to borrow money for big expenses. Take a close look at your situation, the amount you expect to need to borrow, and your possible repayment timeline, then compare those factors to a line of credit (lump-sum, fixed repayment in installments) or a line of credit (flexible borrowing, higher rates) to see which method is best for you.