Difference Between Credit Cards, Personal Loans and Personal Line of Credit
Most people know how credit cards work and they may be familiar with personal loans, but what about a personal line of credit ? All of these options are similar, but they have slight differences that can affect which one you can choose when you need to borrow money. Here’s an example of where 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 fixed period of time ranging from $ 1,000 to $ 100,000. Unlike an individual loan, this type of loan allows you to access funds several times, rather than receive money immediately in the form of a lump sum. Interest is charged upon withdrawal, with borrowers making minimum monthly payments, just like with a credit card.
Personal lines of credit are usually unsecured (which means your property is not used as collateral) and have a variable annual percentage rate (APR) that depends on your credit rating (again, like credit cards). While interest rates on both credit lines and personal loans can range from 6-35% , credit lines tend to be slightly higher. Another difference is that loans to individuals are usually at a fixed interest rate , while lines of credit are at a floating interest rate . However, both options offer lower interest rates than credit cards, which average 16% per annum.
Why would you use a personal line of credit?
For flexibility. Lines of credit are more perpetual than personal loans and are usually used for day-to-day needs when you do not have a fixed cost. On the other hand, personal loans offer a fixed amount of funds in advance, and in order to qualify, you often have to specify exactly what the loan is for, be it home renovations or car repairs.
Of course, the flexibility offered by a personal line of credit makes them potential debt traps. This is why a reliable repayment plan is recommended. Some common scenarios for using a line of credit include:
- Home renovations where cost overruns can be a problem
- Short term medical expenses
- As a financial bridge for occasional or seasonal work
When it comes to 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 daily purchases that can be repaid quickly. If you are looking to finance high-cost, long-term projects that you plan to recoup later, avoid credit cards and stick to personal loans or lines of credit.
Otherwise, avoid borrowing a loan if you cannot afford to repay the debt. And if you’re already struggling to pay off your debts, consider all your options before signing up for an extra loan ( this Lifehacker post will help you ).