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When it comes to paying for some of life’s most important things — like a home renovation, a wedding, or even a funeral — many people choose to use loans instead of cash. And a loan can be especially useful when an expense is creeping up and you just don’t have enough in your emergency fund to cover the entire cost.
A personal loan and a personal line of credit are both forms of credit you can consider. And while they may sound like the same thing, they actually have some very important differences.
Read on for Select’s breakdown of what you need to know about the difference between a personal loan and a personal line of credit.
What is a personal loan?
A personal loan is a form of credit that is granted to you as a lump sum. You can use it to pay for almost any major purchase — home renovations, funeral expenses, medical bills, or even unexpected emergencies if you don’t already have an emergency fund.
People also use personal loans as a form of debt consolidation. Basically, they apply for a personal loan for a certain amount of cash and then use the money to pay off one or more credit card balances that have a higher interest rate than the personal loan they just took out. This can help you save on interest payments when you take out a low-rate personal loan like LightStream, which offers interest rates as low as 2.49%* when you pay with Autopay.
LightStream Personal Loan
Annual Percentage Rate (APR)
2.49% to 19.99%* when you sign up for Autopay
Debt Consolidation, Home Improvement, Auto Financing, Medical Expense, Wedding and others
Penalty for Early Payout
There is no hard and fast rule as to what the loan must be used for, but you are usually required to explain the purpose of the loan when you apply for it. You might even consider using a personal loan to start a small business, just make sure the lender doesn’t prohibit using funds for business purposes (you can read the terms or ask the lender directly).
You must repay the loan amount with interest in fixed, equal amounts each month for a pre-agreed period (called the loan term). For this reason, it is a so-called installment loan. Personal loans usually have a term of two to five years, but can sometimes be repaid over seven years.
Of course, there are many options, but you can make sure you get a personal loan with the best interest rate by comparing different lenders. With this comparison tool from Even Financial you can determine your top offers. The service is free, secure and will not affect your credit score if you do not apply for credit.
Editor’s Note: The tool is provided and operated by Even Financial, a search and comparison engine that matches you with third-party lenders. Any information you provide will be shared directly with Even Financial. Select does not have access to the data you provide. Select may receive an affiliate commission from affiliate offers in the Even Financial Tool. The commission does not affect the selection in the order of offers.
What is a personal line of credit?
Similar to a personal loan, a personal line of credit (PLOC) can also be used for larger expenses. However, it is a form of revolving credit – just like a credit card.
With a PLOC, you have a credit limit and can spend up to that specific amount. However, if you make monthly payments for the spent balance, your Available Balance will be replenished. Essentially, you spend the money as needed and only pay interest on what you borrow. So since you can get approved for $50,000 but only spend $30,000, there’s less pressure to use all of the funds (unlike with a personal loan, where it’s important to know exactly how much to borrow ).
There are two important phases of a PLOC that you should be aware of: the draw period and the cashback period. You can borrow as much as you need during the Drawing Period, but once the Drawing Period has ended and the Redemption Period begins, you will not be able to borrow any more funds. Paying off debt can often be difficult, but we’ve put together some tips to help you launch a strong debt-payment plan.
How much are you paying in interest?
Personal loans have fixed interest rates, while personal lines of credit usually have variable interest rates over time – this depends on the change in the base rate set by the institution lending you money. But in most cases, a higher credit score can help you get lower interest rates.
According to the Federal Reserve, the current average APR on a two-year personal loan is 9.58%. ValuePenguin notes that while the interest rate on a PLOC is variable, it can range from 9.30% to 17.55%, but some lenders, like First Republic, can offer rates as low as 2.25%. In contrast, the average interest rate on a credit card is 16.30% but can go as high as 24%.
However, some credit card issuers offer a 0% intro APR period that can save you money if you’re making a balance transfer to pay off debt or anticipate a large purchase. Just make sure you know how long the offer period lasts.
With the Citi® Double Cash Card, for example, you can transfer your balance interest-free for the first 18 months (thereafter 13.99% – 23.99% variable). Balance transfers must be completed within four months of account opening.
Citi® Double Cash Card
2% Cashback: 1% on all qualifying purchases and an additional 1% after paying your credit card bill
Enter the effective annual rate
0% for the first 18 months on balance transfers; N/A for purchases
13.99% – 23.99% variable on purchases and balance transfers
Prepaid transfers made within 4 months of account opening will incur a prepaid transfer fee of 3% of each transfer ($5 minimum). After that, a transfer fee of 5% of each transfer (minimum $5) will apply
foreign transaction fee
Are there any fees?
A personal loan lender may charge a processing fee and/or an early repayment fee (also known as a prepayment fee) if you repay the loan before its term expires. If you are new to personal loans and want to save as much money as possible, consider a loan with no processing fee, such as B. a Discover Personal Loan.
And while lenders don’t typically charge an early repayment fee for personal lines of credit, they do have some other fees that come with this particular type of loan. An annual fee during the drawing period can range from $25 to $50. A late payment fee can be approximately 7.5% of the overdue amount. And if your payment bounces back due to insufficient funds in your account, or due to a closed or frozen account, you may also be charged a minimum $25 repayment fee.
How should you manage a loan or line of credit?
Regardless of whether a personal loan or line of credit is better for you, always make sure you have a plan to pay it off. In general, you should only try to take on debt that you can afford to pay back, but when life happens and your ability to pay off your debt is compromised, speaking to a financial advisor for some personal advice can help to get the situation under control.
Also, make sure you are familiar with the interest rate and repayment period. Personal loans and personal lines of credit can be powerful tools to help you reach some of your financial and lifestyle goals faster, but they should always be treated with careful planning.
*Your LightStream loan terms, including APR, may vary based on loan purpose, amount, term and your credit profile. Excellent credit is required to qualify for the lowest interest rates. The price is given with AutoPay discount. The AutoPay discount is only available before loan financing. Prices without AutoPay are 0.50 percentage points higher. Subject to credit approval. Conditions and restrictions apply. Advertised prices and conditions are subject to change without notice. Payment Example: Monthly payments on a $10,000 loan at an APR of 3.99% over three years would result in 36 monthly payments of $295.20.
Editorial note: Any opinion, analysis, review, or recommendation expressed in this article is solely that of Select’s editors and has not been reviewed, approved, or otherwise endorsed by any third party.