In the presence of multiple financial products, it is always a struggle to choose the most suitable one. However, to be rational, all financial products are useful in some or other way. You just need to choose the one that matches your circumstances. Personal loans and a Line of credit are two popular loan options that can solve many of your financial needs.
Personal loans Vs Line of Credit – Know how to choose better
Knowing about both the options is the only way to decide which one you should choose. Both have their own features, pros and cons, benefits and disadvantages and uses. A guide below aims to provide you with the required information. Read it, learn and take an informed and rational decision.
What is a personal loan?
A personal loan is a short-term borrowing option that is used to borrow funds for temporary financial needs. The loans typically have a fixed rate of interest, and funds are approved with a customised deal. Personal loans are credit-friendly, hence available to you with a good, fair or poor credit score. Direct lenders offer these loans with a fully digitised process.
- One-time lump sum payment
- Fixed rate of interest
- Fixed repayments
- Typically, unsecured
What is a line of credit?
A line of credit is a revolving credit facility. You are offered a credit limit as per your financial stability and income regularity. You can take and use the money out of the full credit amount as per your requirement. For repayments, you pay interest only on the sum of money you use for your financial need.
- Borrow funds multiple times from the offered limit
- Flexible repayment options
- Interest charged only on the used amount of money
- Can be secured or unsecured
- Revolving access to money
Personal loans Vs Line of Credit – A comparison
Let’s compare both in the most straightforward manner to understand the significance they offer in different ways.
|
Personal loans |
Line of credit |
|
One-time lump-sum disbursement. |
Borrow as needed from the offered credit limit. |
|
Fixed rate of interest that makes repayment budgeting easier. |
Variable rate of interest, but applied only to the used funds. |
|
One-time access to funds without any constraint on purpose. |
Revolving or repetitive access to funds without a purpose constraint. |
|
Usually useful for planned expenses with short to mid-tenure needs. |
Useful for uncertain or ongoing costs, but does not demand a large amount. |
|
Interest charges on the full loan amount. |
Interest is charged only on the used amount of available credit. |
Which one has a lower rate of interest?
Interest rate affects the total and monthly cost of borrowing. Hence, knowing about both of them is vital.
- Lower compared to the line of credit
- Credit-friendly but lower rates for good credit people
- Useful to manage short to medium and sometimes long-term needs.
- Fixed rate of interest makes paying back the loan easier.
Line of Credit
- Variable interest rate (typically)
- Volatile and can increase as per market changes
- Lower rates if secured (such as a home equity line)
- Higher rates if unsecured
Considering the interest rate, it seems that personal loans are comparatively more affordable. The fixed rate of a personal loan makes borrowing pocket-friendly. However, the difference in need matters. If your need is small and uncertain, surely a line of credit is a worthy option.
Repayment flexibility – Which one is more suitable?
- Clear end date with a certain loan tenure
- Fixed monthly payments
- Easier to track
- Less flexible but inspires financial discipline
Line of credit
- No fixed tenure
- Risk to overborrow due to flexible tenure and rate
- Demands self-discipline
- Repayments in the form of interest on used funds only
If you prefer to have a decided tenure and certainty on repayments with a fixed interest rate, choose personal loans. Credit line is flexible, but you have to follow your discipline because there is no decided instalment amount.
How do both affect your budget?
Budgeting matters when you borrow through any credit product. Let’s see how both affect your personal monthly budget.
- Same instalment amount
- Ideal for long-term financial planning
- You are certain about the end of the loan
Line of credit
- Possible fluctuation every month
- Needs tracking every month
- May cause urge to overborrow
Here again, the point of certainty comes under notice. Both options are nice and useful. As per your finances, if you can manage volatile interest rates, choose a line of credit. Otherwise, personal loans are useful.
Impact on credit score
An important concern on which you should always think twice, especially if you have a bad credit score. Let’s read below.
- Initial hard credit check
- Timely payment improves credit score
- Improves credit mix
- Decrease in balance over time
Line of credit
- Affects the credit utilisation ratio
- High usage can make your credit score drop
- Long-term debt risk if you max out the limit
- Improve your credit score if you use it responsibly.
Credit score is a crucial factor. As per the factors above, it seems personal loans are a safe choice. For a line of credit, you have two risks. One is a volatile interest rate that can affect the repayment amount. Second, it can affect your credit utilisation ratio or create debt risk if maxed out. However, the final choice is always based on your financial confidence and the type of need.
Pros of personal loans and a line of credit
A personal loan and a line of credit serve their purposes. Match them with your needs to get the right benefit.
|
Personal loans |
Line of credit |
|
A decided loan amount and repayment schedule |
Good option for ongoing and unpredictable expenses |
|
Predictable repayments with fixed interest rate |
Revolving access to emergency funds for one or multiple needs. |
|
You can fund a large financial need on time. |
You need a small amount of funds for a short-term need. |
|
Consolidate higher interest debts hassle-free. |
You can handle the volatile nature of interest rates. |
Risks and drawbacks
Both have their weaknesses, as nothing is perfect in this world. Hence, know about them and decide better.
|
Personal loans |
Line of credit |
|
Pay interest on the full amount |
Interest on only the used amount |
|
Not as instant as a line of credit |
Not predictable due to variable rate |
|
Early repayment fee (not all lenders) |
No decided end date |
|
Higher rate for bad credit people |
Risk of debt trap for the long-term. |
Knowing the pros and cons of personal loans and lines of credit is another step to help you make better decisions. Use the information above and choose easily which one is better for you.
Conclusive thought
Both financial products are significant in some way or another. It is your personal financial circumstances that decide which one is suitable for you. Today, maybe a personal loan is a better choice for you. Tomorrow, a line of credit may suit you more.
Hence, decide as per your financial needs. Also, your credit score matters. Example for a bad credit score, you’d better consider loans for poor credit from a direct lender. At the same time, a line of credit is also a good option if your repayment ability is weaker. You don’t have any fixed instalment amount.