Line of Credit vs. Personal Loan: Which Is Better?

There are times in life when you may find yourself in need of some extra cash. Maybe you got a new place and need to cover moving expenses, or maybe your car broke down and you need to pay for the repairs. In these situations people often look to borrow money — two common options are a personal installment loan and a personal line of credit.

But which is better?

Personal installment loans and lines of credit are different and one isn’t necessarily better than the other. However depending on your needs as a borrower, one may be better suited for the situation.

What’s the Difference Between an Installment Loan and a Line of Credit?

Installment loan. A personal installment loan is a type of loan that offers borrowers an upfront lump sum of money. The borrower then repays the loan over a set period time in smaller regular payments or “installments.” The specific terms and conditions such as interest rate, repayment period and frequency, and fees will depend on the lender.

Line of credit. A personal line of credit is a form of revolving credit that lets you withdraw the cash you need, when you need it. Instead of getting a lump sum payment, you’ll receive a credit limit that you can borrow against — like a credit card. As you repay, the funds will typically become available again. You often only need to pay interest based on the amount you borrow, though you may also be charged an account maintenance fee or draw fee. Different lenders will have different terms and conditions so be sure to do your research.

When To Use a Personal Installment Loan

Personal installment loans can be good for large, one-time expenses. This could include things like debt consolidation, buying new appliances for your home, or covering the cost of car repairs. These types of loans are useful when you know how much money you’ll need up front. You can apply for the amount you need and pay it off slowly in regular installments (these are often bi-weekly or monthly payments).

Pros and Cons of a Personal Installment Loan

Pros

  • Ability to borrow a large sum. Installment loans are generally issued for larger amounts and have longer repayment periods than other types of loans.
  • Fixed payment amount. Payments are easy to work into your budget because they will usually be the same amount.
  • Fixed timeline. As long as you’re making your payments on time, you know exactly when you’ll pay off your loan.

Cons

  • Reapply to borrow more. If you take out a loan for a project and end up needing more, you’ll need to apply again for more funds.
  • High fees and penalties. Missing payments is never good, but with a personal installment loan you could find yourself paying a steeper price. Some loans have expensive late fees and other penalties that you’ll need to look out for if you miss a payment.

When To Use a Personal Line of Credit

A personal line of credit can be useful in situations where there will be ongoing costs and the price point isn’t fixed. This could include things like moving expenses, paying bills and tackling home renovations. A revolving credit line can also provide a sense of financial security. If you haven’t hit your credit limit, then you know you have funds readily available in case of an emergency.

Pros and Cons of a Personal Line of Credit

Pros

  • Only pay on what you borrow. With a personal line of credit, you’ll usually only pay interest on the amount you borrow. So if you have a line of credit with a $2,000 limit and you’ve only drawn $500, you’ll typically only pay interest on the $500.
  • Ongoing access to funds. As long as your line of credit remains open and you haven’t reached your borrowing limit, you’ll have access to funds when you need them.
  • Flexibility. One of the main features of a line of credit is its flexibility. A line of credit may be useful to have for emergency cash shortages, to supplement an irregular or seasonal income or even to provide peace of mind with easy access to cash, when necessary.

Cons

  • Potential to overspend. The constant access to cash can be tempting to tap into, even when you may not need it. As long as you remember your goals and stick to your budget, you should be able to stay on track.
  • Fluctuating payment amount. The amount you pay probably won’t be exactly the same each month — it will depend on how much you borrow. Also, many lines of credit come with variable interest rates. This can sometimes make it difficult to predict the amount of your bill.
  • Maintenance fees. Even if you don’t take a draw from your line of credit, your lender may still charge you maintenance fees to keep the account open.

Is It Harder To Get Approved for a Personal Loan or a Personal Line of Credit?

Generally, it’s not harder to qualify for one over the other. Approval mostly depends on the lender’s requirements, the amount you’re applying for, your credit history and your financial situation.

If you aren’t approved, consider applying for a smaller loan amount. You can also look for lenders that offer loans and lines of credit that are easier for customers with bad credit to get approved for. These may come with higher interest rates or fees, but they can be helpful in an emergency. Still, you should consider all of your options before deciding if that is the right move for you.

How Do Personal Loans and Lines of Credit Impact Your Credit Score?

How a loan or line of credit affects your credit score heavily depends on if the lender reports to the credit bureaus — Experian, Equifax and TransUnion. If a lender reports to the credit bureaus, the loan or line of credit will appear on your credit report and contribute to your credit history. If the lender doesn’t report to the credit bureaus, the loan or line of credit may not impact your credit in many cases.

Keep in mind that even if a lender doesn’t report to the credit bureaus, the lender may send the debt to collections if you default on your loan.That can have a negative impact on your score.

Personal installment loan. Installment loans can affect your credit in a few different ways. First, when you apply the lender may run a hard credit check to determine approval and loan terms. Hard credit checks can temporarily decrease your credit score. If you’re approved, you’ll need to make your minimum payments on time and in full in order to maintain or build a good credit history. Missed and late payments can damage your credit score. A personal installment loan can also impact your score since it can help you diversify your credit mix.

Personal line of credit. Hard credit checks and payment history will also impact your score with a line of credit. However, you’ll also need to keep an eye on your credit utilization ratio. Your credit utilization ratio is basically the amount of certain types of credit available to you (your credit limit) versus the amount of that credit you’ve used — and contributes to 30% of your FICO Score. Your credit utilization ratio can both positively and negatively impact your score. Many experts recommend staying below 30%.


DISCLAIMER: This content is for informational purposes only, and should not be relied on as advice of any kind. NetCredit and its affiliates do not provide financial, legal, investment or tax advice.

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