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When it comes to paying for some of life’s most expensive items, like a home improvement, a wedding, or even a funeral, many people choose to use credit over cash. And credit can be especially helpful when an expense surprises you and you just don’t have enough money in your emergency fund to cover the entire cost.
A personal loan and a personal line of credit are two forms of credit you might want to consider. And while they may look the same, 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 given to you in the form of a lump sum. You can use it to pay for just about 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 specified amount of money, then use the money to pay off one or more credit card balances that have higher interest rates than the personal loan they just took out. This can help you save on interest payments when you take out a low-interest personal loan, such as LightStreamwhich offers rates as low as 2.49%* if you pay with automatic payment.
Annual Percentage Rate (APR)
2.49% to 19.99%* when you sign up for autopay
Purpose of the loan
Debt consolidation, renovation, car financing, medical expenses, marriage and more
There really isn’t a hard and fast rule as to what to use the loan for, but you will usually need 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, but just make sure the lender doesn’t prohibit using the funds for business purposes (you can read their terms or ask the lender directly).
You will be required to repay the loan amount with interest in fixed, equal amounts each month for a predetermined period of time (called the loan term). For this reason, it is called installment credit. Personal loans usually have a term of two to five years, but can sometimes be repaid over a period of seven years.
Of course, there are many options, but you can ensure you get a personal loan with the best interest rate by comparing different lenders. You can use this comparison tool from Even Financial to determine your best deals. The service is free, secure and will not affect your credit score if you do not apply for a loan.
What is a personal line of credit?
With a PLOC, you have a credit limit and can spend up to that specified amount. But as you make monthly payments on the balance you’ve spent, your available credit is replenished. Essentially, you spend the money as needed and only pay interest on what you borrow. So, because you can be approved for $50,000 but only spend $30,000, there’s less pressure to use all the funds (unlike a personal loan, where it’s important to know exactly how much you’ll need to borrow).
There are two important phases of a PLOC that you need to be aware of: the drawdown period and the redemption period. During the draw period, you can borrow as much as you need but once the draw period is over and the repayment period begins, you cannot borrow any more credit. Paying off debt can often be tricky, but we’ve put together some tips that will help you get started on a solid debt repayment plan.
How much do you pay in interest?
Personal loans carry fixed interest rates while personal lines of credit generally have variable rates over time — this will depend on how the prime 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 Federal Reservethe current average APR for a two-year personal loan is 9.58%. ValuePenguin notes that although variable, the interest rate for a PLOC can range from 9.30% to 17.55%, but some lenders, such as First Republiccan offer rates as low as 2.25%. On the other hand, the average interest rate on a credit card is 16.30%, but can reach 24%.
However, some credit card issuers offer a 0% intro-APR period, which could save you money if you’re doing a balance transfer to pay off a debt or are expecting to make a purchase. important. Just make sure you know how long the offer period is.
the Citi® Dual Charge Card, for example, allows you to make a balance transfer without paying interest for the first 18 months (after, 14.24% – 24.24% variable). Balance transfers must be completed within four months of account opening.
2% Cash Back: 1% on all qualifying purchases and an additional 1% after you pay your credit card bill
0% for the first 18 months on balance transfers; N/A for purchases
14.24% – 24.24% variable on purchases and balance transfers
Balance Transfer Fee
For balance transfers made within 4 months of account opening, an initial balance transfer fee of 3% of each transfer ($5 minimum) applies; after that, a balance transfer fee of 5% of each transfer ($5 minimum) applies
Foreign transaction fees
Are there any fees?
A personal lender may charge a origination fees and/or prepayment fees (also called prepayment fees) if you repay the loan before the end of its term. If you’re new to personal loans and want to save as much money as possible, you might want to consider one that doesn’t have origination fees, such as a Discover the personal loan.
And while lenders don’t typically charge prepayment fees for personal lines of credit, they do have a few other fees that come with this specific type of loan. An annual fee during the draw period can cost you between $25 and $50. A late payment fee can be approximately 7.5% of the overdue amount. And if your payment bounces due to insufficient funds in your account or due to a closed or frozen account, you may also be charged a return payment fee of at least $25.
Whether a personal loan or a personal line of credit is best for you, always make sure you have a plan to pay them back. As a general rule, you should only try to take on debt that you can afford to repay, but if life happens and your ability to repay debt is affected, speaking to a financial adviser for personalized advice can help. help take control of the situation.
Also, make sure you’re comfortable with the interest rate and repayment schedule. 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 handled with careful planning.
*The terms of your LightStream loan, including APR, may differ depending on the purpose of the loan, amount, term and your credit profile. Excellent credit is required to qualify for the lowest rates. The fare is shown with the AutoPay discount. The AutoPay rebate is only available before the loan is funded. Rates without AutoPay are 0.50% higher. Subject to credit approval. Conditions and limitations apply. Advertised rates and conditions are subject to change without notice. Payment Example: Monthly payments for a $10,000 loan at 3.99% APR with a term of three years would result in 36 monthly payments of $295.20.
Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.