If you’re looking for a strategy to consolidate debt, you may have come across two common options: a personal loan or a personal line of credit.
What are the important differences between the two, and how do they matter for your financial situation?
The key differences could cost you if you’re not careful, so continue reading to learn more about obtaining a line of credit versus a personal loan.
What is a personal line of credit?
A personal line of credit is a limited amount of money to borrow that a financial institution extends to an individual. Essentially, it means a bank provides you access to a certain amount of money, which you can spend and pay back with interest.
When it comes to consolidating debt, you apply for a line of credit to pay off multiple debts or use the money for any purpose. Lines of credit may either be secured or unsecured. A secured line of credit, such as a home equity line of credit or HELOC, requires collateral. An unsecured line of credit, such as a credit card, does not require collateral from the borrower to the bank.
What is a personal loan?
A personal loan is also issued by a bank or financial institution. The funds can be used for many things, but they are commonly used for a specific purpose such as:
- Debt consolidation
- Wedding and vacation financing
- Handling unexpected expenses
- Upgrading to more energy-efficient appliances
Once you’re approved for a personal loan, the financial institution issues the money to you and it is paid back over a fixed period of time. At Discover® Personal Loans, repayment plans range from 36 to 84 months.
Key differences between a line of credit and a personal loan to consolidate debt
Interest rates
A revolving line of credit may have a variable interest rate, meaning the interest rate and payment amount can change from month to month. With a personal loan, your interest rate is fixed and is determined by factors such as your credit score and financial history. This allows you to plan and budget knowing your payment will be exactly the same from month to month.
Access to credit vs. receiving a lump sum
With a personal line of credit, you can spend up to the maximum credit line, but it is up to you to pay your creditors. Also, while you have access to the credit line, money does not go into any of your bank accounts. Some lines of credit, including HELOCs, only allow you to spend money through a separate account linked directly to the credit line. This account could act like a credit card or a separate checking account.
However, with a personal loan, you can receive a lump sum amount once you’re approved and accept the terms of the loan. The money could be deposited directly into your bank account or sent to you by check. If you are using a personal loan to help with debt consolidation, payments can be sent directly to your creditors as well.
Fees
With a line of credit, there may be additional fees, such as upfront costs or transaction fees. It’s a good idea to check what rates and fees apply when establishing and using a personal line of credit. Remember, the lender pays for the transactions up to a certain amount and will then collect the debt (and any additional fees) for the transactions from you on their terms and their rates. This means that the payment you owe may change from month to month.
Personal loans are taken out at a fixed rate. As a result, you’ll have a set regular monthly payment. Some personal loan providers do charge origination or processing fees, so you could save money by looking for a lender like Discover that charges no fees of any kind as long as you pay on time. Why pay those fees if you don’t have to?
Discover also allows you to check your rate on a personal loan without affecting your credit score. Check Your Rate