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Line of credit vs personal loan which is better for you

line of credit vs personal loan

Looking to get your finances in order with either a line of credit or personal loan? Depending on your circumstances, either form of funding could be an essential financial tool. 

Many personal loans are for emergency needs when people don’t have a job or income, like paying for car repairs, essential home fixes, or debt consolidation. Alternatively, a personal line of credit is meant for more varying ongoing expenses when you don’t always know how much you’ll need until the need is immediate.

Whether you’re trying to pay off debt or trying to learn more about what a line of credit means, you’ve come to the right place. Want to learn more about whether a personal line of credit or a personal loan is the right financial decision for you? Great news, you’ve come to the right place! 

What Is a Personal Line of Credit? 

Different from personal loans, a line of credit is a predetermined amount of money accessible to the account holder on an as-needed basis for a defined period of time. Personal lines of credit allow people to withdraw money up to their predetermined credit limit to cover expenses whenever and if ever they need it. This freedom means that people who take out personal lines of credit do not have to use their total funded amount. This is different from loans like online cash advances or personal installment loans.

A personal line of credit also usually comes with a variable interest rate. How much money the credit holder uses within their given draw period will determine how much they pay in interest. The more someone borrowers off of their line of credit, the higher their interest rates and interest payments will be. 

What Is the Difference Between a Secured and an Unsecured Line of Credit? 

Knowing the difference between unsecured vs. secured debt is very important. Because there are only two types of credit lines; secured and unsecured. An unsecured credit line is when financial services approve a predetermined credit limit based on the applicants’ credit score, spending habits, financial history, etc. A secured personal line of credit is when approval is based on the equity in a piece of property used as collateral. 

A credit card is an example of an unsecured line of credit, also called an unsecured personal line. Financial products like credit cards extend revolving credit to customers in good faith that they will meet their minimum monthly payments. Because of the lenders’ financial risk, unsecured lines of credit usually require excellent credit and can come with higher interest rates and an annual fee. 

A Home equity line of credit, also known as a HELOC, is considered a secure line of credit. With this type of funding, the borrower’s home is used as collateral as the financial institution extending the credit line places a lien on the property. 

What You Need To Know About Personal Loans 

A personal loan is one lump sum amount granted to a borrower, who then receives all the money upfront. Most personal loans come with fixed interest rates, origination fees, a set minimum payment, and defined repayment periods. 

Usually, people pay back personal loans in fixed payments. But, borrowers are encouraged to pay more each month to save on charged interest. However, if you want to pay back your personal loan in a fixed amount, setting up an autopay system might be something to consider. 

When you pay back personal loans with autopay, the money is taken directly out of your checking account for monthly payments. While it’s still important to stay on top of your repayment period, autopay can relieve some of the stress of remembering to make your loan payment each month. 

A personal loan may also serve as a huge financial relief if you find yourself in need of immediate one-time funding. Suppose you’re looking to make some home improvements and have a set budget as to how much your improvements will cost. In that case, a personal loan may be an excellent option for covering those expenses. Instead of applying for a credit card or other lines of credit for a large one-time expense, you may want to consider personal loans instead. 

Unsecured Personal Loan vs. A Secured Loan

Unsecured personal loans are a way for people to borrow money without having to put up any property as collateral. Knowing how to qualify for an unsecured loan is important. When lenders grant approval for unsecured loans, they look at a potential borrower’s credit history and credit report to determine factors like their interest rates, loan terms, and funded amounts. Student loans are an example of an unsecured loan. 

A secure personal loan is funding backed by collateral. Instead of looking at a loan applicant’s credit and financial history, the equity, also known as the value of a piece of property, is used as collateral to secure the loan funding. 

A car loan is an example of a secure loan. In this case, the vehicle’s value is used as collateral to secure the loan money. If a borrower defaults on a secured loan, the lender has the right to claim the collateral for the money they lost. 

Is a Personal Loan or Personal Line of Credit Better for My Credit Score?

Both personal loans and personal lines of credit have the ability to positively affect credit scores when used properly. When you have good credit, lenders are more likely to offer you a Prime rate or higher funded amounts for a personal loan or line of credit. 

The first aspect of your credit report that a personal loan or line of credit may affect is your payment history. When you borrow money and make your monthly payment on time, this action positively reflects on a credit score. 

With both a personal loan and a personal line of credit, a late payment fee can have a major negative impact on your credit report. Furthermore, if you fail to make payments all together your loan or line of credit may fall into default. When borrowers default on a personal loan or personal line of credit, their credit score usually goes down significantly. 

To avoid negative penalties from a personal loan or personal line of credit on your report, stay on top of your loan term and try to make more than the minimum payments due each month. You don’t always have to make the same payment amount, just what you can when you can. The faster you pay off your credit line or personal loan, the sooner you’ll be able to benefit from the financial rewards! 

References:

Investopedia—Lines of Credit: The Basics

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