Whether you need to borrow money for a specific purpose or want a just-in-case backup option, there are several types of credit available to you. Knowing the difference between lines of credit and personal loans can help you decide which option will work best for your situation.
A line of credit functions as a revolving loan. You’re given a credit limit, you don’t make payments or accrue interest if you don’t use it , and you can usually borrow any part of the available credit line — which you can continue to do each time you’ve repaid the money borrowed. Often, a line of credit will have a variable interest rate.
A personal loan — often referred to as an installment loan, loan, or unsecured loan — however, is a lump sum. You typically receive the entire loan once you close the loan with the bank, but you must start paying interest on the full amount right away. A personal loan typically has a fixed payment and a fixed interest rate.
There are benefits and limitations to each, of course, depending on your cash flow and when you need the money, says Susan Fisher, Regions Bank Priority Banker and Branch Team Leader in Brentwood, Tennessee.
“A line of credit is ready and waiting for you,” Fisher says. “It’s like being able to go to the faucet and turn the water on. If you don’t need water, you don’t turn the faucet.”
A line of credit is beneficial for unexpected emergencies, as one of Fisher’s clients found out several years ago. After a brutal winter storm damaged his home — and before the insurance coverage investigation and approval process took place — he was able to use his untouched home equity line of credit to make the necessary and immediate repairs to his home.
Of course, a line of credit needs to be in place ahead of time, but length of time varies by product. “The application process can take a few weeks, so it’s not something you want to wait until the last minute to do,” Fisher says. It is helpful to have a line of credit in place before you need it. Some lines of credit may have fees, such as an inactivity or annual fee, and you will need to determine if the convenience is worth the cost.
If you know how much you’ll need to borrow and when you’ll need the money, a personal loan might be a better option. These installment loans are typically used for specific purposes, such as a car or planned home improvements, and once you’ve paid it off, the loan is completed.
“Since most people know exactly when they’ll receive their next paycheck and when their loan payment is due, it helps them to manage their cash flow,” Fisher says. “Plus, you’re not subject to fluctuating interest rates since the rate is typically fixed.”
If you decide you need more money once the loan is paid off, however, you have to apply for a new loan. Also, you may run the risk of no longer qualifying for a loan if your income or employment situation has changed.
Whatever your circumstance, a banker or financial advisor can help you determine which borrowing option will fit your needs.
“A good personal banker won’t just spout off about products,” Fisher says. “They’ll listen to your unique situation and make suggestions that are right for you.”
There are many uses for both lines of credit and personal loans. Consider your needs and your financial situation as you plan ahead for your future.