The difference between credit cards, personal loans and a personal line of credit
Most people know how credit cards work and they might be familiar with personal loans too, but what about a personal line of creditt? All of these options are similar, but they have subtle differences that can affect which option you might choose when you need to borrow money. Here’s a look at when you would use a line of credit instead of a credit card or personal loan.
What is a personal line of credit?
Personal lines of credit are indefinite loans that allow a borrower to withdraw funds as needed, over a specified period of time, for limits ranging from $ 1,000 to $ 100,000. Unlike a personal loan, this type of credit allows access to funds multiple times rather than getting the money upfront as a lump sum. Interest accrues after funds are withdrawn, with borrowers making minimum monthly payments like a credit card.
Personal lines of credit are generally Insecure (which means your property is not used as collateral) and have a variable annual percentage rate (APR) which is based on your credit score (again, like credit cards). While the interest rates on lines of credit and personal loans can be in the range 6-35%, lines of credit tend to have slightly higher rates. Another distinction is that personal loans generally have fixed rates, while lines of credit tend to have variable rates. That said, both options offer cheaper interest rates than you would get with credit cards, which are 16% APR on average.
Why would you use a personal line of credit?
For flexibility. Lines of credit are more open than personal loans and tend to be used for ongoing needs that don’t have a fixed cost in mind. Personal loans, on the other hand, offer a set amount of funds up front, and to qualify you often need to state exactly what the loan is for, whether it’s home renovations or auto repairs.
Of course, the flexibility offered by a personal line of credit makes them potential debt traps. This is why a solid repayment plan is recommended. Here are some common scenarios in which a line of credit can be used:
- Home renovations where cost overruns could be a concern
- Short-term medical expenses
- As a financial bridge in the event of irregular or seasonal work
As for credit cards, they offer cash back rewards and tend to have higher interest rates than personal loans or lines of credit, so they are better suited for everyday purchases that can be paid off quickly. If you’re looking to fund expensive, long-term projects that you plan to pay off later, avoid credit cards and stick with personal loans or lines of credit.
Otherwise, avoid borrowing credit if you can’t afford to repay it. And if you’re already struggling to pay off your debt, consider all of your options before taking out more credit (this Lifehacker post has you covered).