Personal Line Of Credit Vs. Personal Loan: How To Choose The Right Option

At some point in your life, you may need financial assistance for a large expense that you didn’t see coming. Or, maybe you want to consolidate debt or complete some home repairs. Whatever the reason, several financing options can provide you with the money you need.

Among the most common funding options are a personal loan and a personal line of credit. Let’s explore how a personal loan and a personal line of credit are different and when each could be the right choice for your situation.

A personal line of credit (PLOC) gives you a revolving credit line, similar to what you have with a credit card. You can access this line of credit as needed over a set draw period and repay the funds you use throughout the draw period, during the repayment period or during both. On the other hand, a personal loan is a lump-sum payment that you pay back over a designated loan term of – in all likelihood – a few years.

While these two financing options can serve similar purposes, you can make a few noteworthy distinctions between them. Here’s a quick snapshot of their differences so you can easily see which option may best serve your needs.

Distribution Of Funds

One big difference between personal loans and personal lines of credit is how you gain access to your money. With a personal loan, you usually get all the funds in one upfront payment.

With PLOCs, you’re typically approved to use the line as needed up to a certain limit. You often have ongoing access to funds through a card or check linked to the account. If you reach the credit limit, you can pay off the balance. As you make payments, the credit you’ve used becomes accessible again. You can repeat this cycle until the draw period ends.

Repayment Process

Another major difference between a personal loan and a personal line of credit is how the borrower pays back the money they owe.

With PLOCs, the draw period and repayment period are technically separate. As a result, only minimum or interest-only monthly payments (payments not for the full balance you owe) are required until the draw period ends and the repayment period begins. However, borrowers may opt to make larger payments during the draw period to free up funds for withdrawal.

On the other hand, personal loan borrowers tend to pay off the loan in fixed monthly installments for a predetermined time. This repayment term typically starts once the lender disburses the funds. If payments become too much for a borrower, the lender may let them restructure or refinance the loan to lower the monthly expense.

Interest Rates

Both personal loans and personal lines of credit charge interest, but PLOC interest rates are typically higher and variable, meaning they fluctuate. Personal loans commonly have fixed interest rates, meaning they won’t change. And, in many cases, personal loans have lower interest rates than PLOCs.

Personal loans and lines of credit also accrue interest differently. Personal loan interest starts as soon as you receive your funds, but you don’t pay interest on a PLOC until you use the funds – and you only pay interest on the funds you use.

Both personal loans and personal lines of credit can be secured or unsecured. You put up an asset, such as a home or car, as collateral on a secured personal loan or secured line of credit in the event you fail to repay your lender. No collateral is necessary for an unsecured personal loan or an unsecured personal line of credit. Rocket Loans^SM offers unsecured personal loans.

Personal loan eligibility requirements tend to be slightly less strict than those for a PLOC, but the repayment schedule on a PLOC is more flexible since you won’t have to make anything but minimum or interest-only monthly payments for an extended period of time.

Here’s a closer look at the requirements you can expect for each.

While individual lenders all have specific requirements, they tend to focus on the following traits in borrowers seeking a personal loan or a line of credit:

• Credit history and credit score
• Income source
• Debt-to-income ratio

Most lenders assess a borrower’s creditworthiness by reviewing their credit history, which includes their credit report and credit score. Taking steps to build your credit can improve your chances of approval. Before applying for a PLOC or a personal loan, checking your credit report for any errors is also wise.

Personal loans can help if you need substantial financing for a project or another big one-time expense. You can access funding without putting a heavy dent in your savings or paying back what you owe right away. Plus, qualifying for a personal loan can be a little bit easier than qualifying for a PLOC if you don’t have good credit.

The consistent personal loan repayment schedule also makes budgeting for monthly payments simpler. As a result, a personal loan may be more financially sustainable than a PLOC.

A personal loan works best when you know exactly how much money you need. You can use a personal loan for, among other items:

• Debt consolidation
• Large purchases (such as a car, motorcycle or boat)
• Emergency charges
• Small- to medium-sized home improvement projects

Personal Loan Risks To Consider

Since a personal loan is a set amount of money, the loan amount might not be enough to cover the expenses you need it for.

Significant changes in how you plan to spend the money, or the amount of money you need, might result in the funds not being enough to cover everything. In this case, a personal loan might not be your best option. Suppose, for example, that you’re halfway through a major home renovation and discover a leak in your roof caused the underlayment to start rotting. To fix the issue, you’ll probably have to spend more than you planned on spending. This can be especially problematic if you already budgeted for the project and got approved for a specific loan amount.

However, this doesn’t mean you should necessarily avoid using a personal loan for any type of home improvement project. Personal loans can be an excellent way to finance smaller-scale projects, such as upgrading kitchen appliances, replacing bathroom tiles or building a deck. Improvements of this nature are less likely to uncover hidden problems.

Also keep in mind that some personal loans require an application fee. You could face a prepayment penalty if you pay off your loan before the repayment term ends. Rocket Loans does not charge this type of penalty for prepayment.

Personal lines of credit can act as a great option if you aren’t sure exactly how much money you’ll need. A PLOC can give you more flexible access to money over a longer period of time. And, you can make payments in relatively small increments – at least for a while.

You can use a PLOC for ongoing medical expenses, large home improvement projects, business investments and more.

Personal Line of Credit Risks To Consider

Due to the inconsistencies that can occur with how much of the available credit limit you use, PLOCs can be tricky to budget for. You may also be tempted to charge expenses and pay them off when you feel like it. This can cause you to quickly accrue interest without notice. You’ll likely have a high interest rate, which can make racking up a substantial amount of debt even more likely.

Lenders may charge you an application fee and an annual fee to use a PLOC. If you miss a payment on your account or make too big of a purchase, you may owe late or overdraft fees. These charges can make this financing option more expensive than a personal loan.

When choosing between a personal loan and personal line of credit, it’s important to assess which option’s features best suit your needs. Consider whether a personal loan or a line of credit is the most sustainable for your personal finances with regard to making payments and adding the expense to your budget.

If you’ve decided that a personal loan sounds like the right choice for you, Rocket Loans is here to help! Get started on your journey toward financing approval today.