One of the most versatile loans you can get from a financial institution is a personal loan. You can use the money for anything from funding your wedding or vacation to consolidating your debts. However, there’s another way to borrow money from a financial institution that is even more versatile than a personal loan--a personal line of credit
Instead of borrowing a lump sum, a personal line of credit instead lets you borrow up to a certain amount of money and only pay interest on the amount you borrow. Even better, you can repay part or all of the money you borrowed on your personal line of credit, and it will be available for you to borrow again.
These two financial vehicles are so similar most people wonder if there’s any difference between one or the other. In fact, there are situations where a personal line of credit is a better choice than a personal loan, and vice versa.
Personal loans give you a large sum of money all at once. This makes them ideal for large one-time expenses that you wouldn’t ordinarily be able to afford.
Large bills are one of the best examples of this. If your transmission goes out and your mechanic says the bill will be $3,000, you’ll need to pay off the entire amount at once, but at least you’ll know you won’t have anything else to pay.
Another smart way to use a personal loan is for debt consolidations. All you have to do is add up each debt you have, then get a loan for the amount you’ll need to pay them off. While personal loan rates are higher than other loans due to them being unsecured, they'll be significantly lower than the interest rates on common types of debt like credit cards and payday loans.
While personal loans are best for one-time expenses, personal lines of credit are best for projects where you don’t know how much you’ll need to spend.
The best example of this would be home improvement projects. You might have an estimate of how much money you’ll need to complete the project, but you have no way of knowing if the final cost will be more or less than the estimate.
This is where a personal line of credit can really help. You only borrow as much as you need, which means you won’t be paying interest on money you didn’t have to use the way you would with a personal loan. You also won’t have to worry about running out of money or having to fund the remainder of the project out-of-pocket if the project goes over budget.
You can also use personal lines of credit if you’re in a career that doesn’t provide regular paychecks, like a contractor or a freelancer. You can borrow enough from your personal line of credit to cover your expenses until your paycheck comes in, then repay that amount back to your line of credit.
While there are clearly some situations in which a personal line of credit will work better than a personal loan and vice versa, you should be aware that there are also several scenarios in which either one might work.
If you’re moving, for instance, you should have an idea of how much the movers will charge, as well as the costs to turn on the utilities in your new home, so a personal loan would be a good idea.
On the other hand, if an unexpected expense arises, you’ll be glad to have access to more money. You might need a new appliance or a new piece of furniture, or you might need to rent some storage space.
If you find yourself in a situation where either a personal loan or a line of credit could work, you can figure out which one will work best for you by asking two questions.
The first question is what is the likelihood of an unexpected expense popping up? With a wedding, for instance, you probably won’t have to worry too much about unexpected expenses. A vacation, on the other hand, almost always has an unexpected expense or two pop up, whether it’s having to stay an extra night at a motel, visiting a tourist attraction you didn’t realize you would be near or even having to pay for an emergency repair.
The second question you want to ask is how financially disciplined are you? Personal lines of credit are ideal for situations in which you don’t know how much you’ll need to spend, but if you’re prone to impulse buying, the temptation might be too great.
Personal lines of credit and personal loans are both very versatile financial tools that can help you achieve financial success. In order to figure out which one will work best for you, think about whether you need a fixed amount, whether or not you’ll encounter unexpected expenses and whether you’re financially disciplined or not.
If you have a project you’d like to fund with a personal loan or a personal line of credit, become a First Alliance Credit Union member today. We offer a personal line of credit that offers no annual fees, no funds transfer fees and can even connect to your checking account to cover overdrafts.