Personal loan versus line of credit: Which should you choose?

Personal loans versus lines of credit

With a personal loan, you borrow a single (fixed) amount of money from a bank or other lender. In return, you agree to pay back the principal and interest within a certain period of time. This is called an “installment credit.” Generally, personal loans are for specific expenses. For example, you can apply for a car loan to buy a car, or a credit consolidation loan to reduce your debt. Personal loans can be secured or unsecured, and the amount you qualify for depends on your credit history and financial picture.

When you are approved for a line of credit, a bank, company or lender extends a certain amount and you can borrow as needed. Whatever you pay, you can access credit again, like a credit card. This is called “revolving credit.” You can use the money for any purpose you wish. Like loans, lines of credit can be secured or unsecured.

Here are the important differences at first glance.

Pros and cons of personal loans

Here are the pros and cons of personal loans.

Benefits

• Interest rates can be lower than credit cards
• A fixed payment schedule ensures that your loan will be paid on a specific date.

Evil

• Interest rates are much higher than most lines of credit.
• To use more credit you must refinance the loan or get another loan.
• Lenders may charge loan administration fees.
• There may be limits on what you can spend money on. A car loan is only for buying a car, which may seem obvious, but other loans may be used only for repairing or consolidating debt.

Pros and cons of a line of credit

Here are the pros and cons of lines of credit.

Benefits

• It usually has lower interest rates than personal loans.
• Interest is charged only on the part of the credit used.
• There is no time limit to pay it off at any time without penalty (as long as you pay the minimum monthly amount).
• The credit is “revolving”, which means that once you have paid it off you can borrow again without paying the money back.
• You can use the money for any purpose.

Evil

• Interest rates vary, based on the principal amount, so the loan amount will fluctuate. For example, you may have a line of credit where the interest rate is + 1.5%. As the principal amount changes, so does the total interest on your line of credit.
• Lenders often offer a higher rate that makes it easier to borrow.
• Since there is no fixed payment plan, you must manage the payment yourself.
• A secured line of credit against your home (such as a HELOC) will require an appraisal as well as legal fees.

How interest rates work on loans and lines of credit

The interest you pay on a personal loan or line of credit will depend on many factors including the lender, your credit history, the terms of the loan and the principal amount (if there is variable interest). That said, these are variables that you can negotiate to get the best rates.

For personal loans:

• Interest rate
  Look for the lowest rate you can get, and decide whether you prefer a fixed or variable rate.
• Fixed or variable rate
  Loans are usually fixed rate, meaning that the interest rate remains the same throughout the term of the loan. With a variable rate loan, the interest rate will change in the same direction as the principal amount.
• Secured or unsecured
  You may be able to negotiate a lower interest rate if you can secure the loan with collateral, such as a home.
• Time to pay the bill
  Amortization is the amount of time it takes to pay off the loan and can range from six months to 60 (five years) for a personal loan, reports the Financial Consumer Agency of Canada. Adjusting your amortization period may affect your interest rate.
• Fees or fines
  Loans come with fees. With a personal loan, for example, you may pay a penalty if you pay it off early.

For lines of credit: