Most people know how credit cards work, and they may also be familiar with personal loans – but what about one? personal line of creditT? All of these options are similar, but they have subtle differences that can affect which option you can choose when you need to borrow money. This is where you can see when you would use a line of credit versus a credit card or personal loan.
What is a personal loan?
Personal lines of credit are perpetual loans that allow a borrower to withdraw funds as needed over a set period of time, up to limits of $ 1,000 to $ 100,000. Unlike a personal loan, this type of loan allows multiple access to the money instead of receiving the money in advance as a lump sum. Interest accrues as soon as funds are withdrawn, with borrowers making minimum monthly payments like a credit card.
Personal lines of credit are usually available unsecured (which means your property is not used as collateral) and have a variable annual percentage rate (APR) based on your credit score (again like credit cards). While the interest rates on both lines of credit and personal loans can be in the range of 6-35%, Lines of credit tend to have slightly higher interest rates. Another difference is that personal loans are typically Fixed priceswhile lines of credit tend to be variable rates. However, both options offer interest rates that are cheaper than what you would get with credit cards 16% APR on average.
Why should you use a personal line of credit?
For flexibility. Lines of credit are perpetual as personal loans and are typically used for ongoing needs where you don’t have fixed costs in mind. Personal loans, on the other hand, offer a fixed amount upfront, and to qualify you often need to specify exactly what the loan is for, be it a home renovation or car repairs.
The flexibility that a personal loan offers naturally makes them potential debt traps. This is why a solid repayment plan is recommended. Some common scenarios where a line of credit could be used include:
- Home renovations where cost overruns could be an issue
- Short term medical expenses
- As a financial bridge for irregular or seasonal work
Credit cards offer cashback rewards and tend to have higher interest rates compared to personal loans or lines of credit, making them better for daily purchases that can be paid off quickly. If you’re looking to fund expensive, long-term projects that you want to pay off later, avoid credit cards and stick to personal loans or lines of credit.
Otherwise, avoid borrowing when you cannot afford the repayment. And if you are already struggling to pay off debts, consider all of your options before applying for another loan (This Lifehacker post has you covered).