What’s the difference between a personal loan and a line of credit?

When you need to access money in a hurry, it might be tempting to use whatever financing option is available at your fingertips. If you have access to a line of credit through your mortgage or business, you could be considering using either of these.  

While lines of credit can be a handy tool in emergency situations, such as unexpected home maintenance or dental work, they are not always the best idea.

It’s important to take the time to understand the differences between a personal loan and a line of credit so you can make an informed decision that you won’t regret down the track.

Key differences

Let’s take a quick look at the differences between a personal loan and a line of credit.

A personal loan is a lump sum provided for a purchase of almost any kind.

A line of credit, on the other hand, is a reusable loan that you can access as often as you like up to your credit limit. Just like a credit card, you can use a line of credit to buy whatever it is you need or want.

A personal loan comes with a repayment schedule and is generally paid off between 12 months and 7 years. And you generally can’t redraw on your car loan repayments.

Unlike a personal loan, a line of credit has no set loan term or repayments. You simply pay a percentage of your monthly credit balance or a set amount, whichever is greater. Once you’ve repaid a line of credit, you can withdraw the money again if something else comes up.

Most personal loans come with a fixed interest rate. This means you’re protected from market fluctuations and can easily budget as the repayments never change throughout the life of the loan.

The interest rate on a line of credit is generally variable and is likely to be higher than that of a personal loan. A variable interest rate means your repayment amounts can change as they respond to the rises and falls of the economic market.

Three reasons why you shouldn’t use a line of credit

A line of credit might seem like a convenient solution, here’s three reasons why you should think again.

1. Unlike a personal loan, a line of credit has no set loan term or repayments. Without set monthly repayments, it can be harder to manage the debt and make paying it off a priority. Unless you are very disciplined, you could still be paying it off for longer than you think. Also, if you fail to make repayments, your credit score will take a hit. 

2. A line of credit comes with a higher interest rate than a personal loan. This means the overall cost of the loan will end up being higher.

3. A variable interest rate on a line of credit means your repayment amounts could change as the rate fluctuates. This makes it difficult to budget correctly for repayments and stay in control of your finances.

The bottom line

If you plan to use a line of credit make sure you’re aware of the risks and dangers. Taking out a personal loan instead is a generally a faster track to financial freedom. Remember, a personal loan allows you to budget for fixed repayments and easily track your progress. When your loan is finished, you can bask in the satisfaction of knowing you’ve paid everything off.  

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