If you’re looking for a strategy to consolidate debt, you have may have come across two common options: a personal loan or a line of credit.
So which option should you choose?
Although both are forms of loans from financial institutions, there are key differences that could cost you if you’re not careful. Continue reading to learn more about obtaining a line of credit versus a personal loan, and their key differences.
What Is a Line Of Credit?
A (personal) line of credit is a credit source extended to an individual by a financial institution and usually requires you to have a checking account with that institution. Essentially, that just means the bank provides you access to a certain amount of money, which you can spend up and pay it back with interest.
Investopedia states “This means that the borrower can spend the money, repay it and spend it again, in a virtually never-ending, revolving cycle.”
When it comes to consolidating debt, the borrower could obtain a line of credit to pay off debts at multiple places or use the money for any purpose. Sometimes lines of credit are “secured,” such as a home equity line of credit, and sometimes they are “unsecured,” meaning that no collateral is put up by 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 bills
- Upgrading to more energy-efficient appliances
Once you’re approved for a personal loan, the financial institution issues the entire amount of 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
A revolving line of credit may have a variable interest rate, meaning the amount of interest you pay 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.
Receiving a Lump Sum vs. Access to Cash
With a personal line of credit, you can spend up to the maximum credit line, but it is up to you to pay creditors, and although the money is accessible, the maximum credit amount is not deposited automatically into your bank account or sent to you by check.
With a line of credit, it is possible that your APR will vary and other fees may apply, such as transaction fees or inactivity fees for not using the line of credit.
Personal loans are taken out at a fixed rate. As a result, your monthly payment won’t change .
Some personal loan providers do charge origination or processing fees, so you could save money by looking for a lender like Discover that offers a loan product without those costs. Why pay those fees if you don’t have to?