A personal loan provides you with a fixed amount of money upfront that you repay in regular installments over a set period. In contrast, a line of credit offers you the flexibility to access funds as needed, up to a certain limit, and you only pay interest on the amount you use. With a loan, you get the entirety of the funds at once and pay it back in regular installments. A line of credit, on the other hand, allows you to borrow as needed, up to a certain limit, and repay based on what you have borrowed.
Comparing personal loans and lines of credit
Both personal loans and lines of credit serve as valuable resources when you are looking to handle substantial expenses such as purchasing a car or funding home improvements. However, understanding their mechanisms can guide your decision-making process in selecting the one that aligns better with your specific requirements. It is like having two different tools in your financial toolbox—each suitable for various situations. By comprehending how they operate, you can pick the one that best suits the job at hand, whether it is a fixed loan amount with regular payments or a flexible credit line to tap into when necessary.
Personal loan definition
A personal loan, which is also known as an installment loan, involves borrowing a specific sum of money from a bank or lender. You commit to paying back this amount, along with interest, within a predetermined duration according to a set schedule of payments
Line of credit definition
A personal line of credit is akin to a flexible form of borrowing provided by banks or credit unions. It grants you continual access to a predetermined sum of money that you can use whenever necessary. The catch is that you only accrue interest on the portion of the funds that you withdraw from this account. As long as you meet the minimum monthly payments, your line of credit remains active and available for further use, offering you ongoing financial support.
Common features
They share certain characteristics despite their differences. They both provide access to funds, allowing you to borrow money to cover various expenses. Additionally, both options typically involve interest charges on the borrowed amount. Furthermore, they are financial tools offered by banks or lenders to assist individuals in managing their finances, albeit in different manners. Despite their distinct structures, they are akin in their fundamental goal of providing financial support when needed.
Criteria to qualify
Most financial institutions have a minimum set of criteria that you must pass to qualify to apply for a loan or line of credit, including:
- A resident of Canada. You may need to prove that you are a resident of Canada.
- Age of majority. You will likely need to be the age of majority in your territory or province.
- Income or employment. Lenders may require that you show proof of income such as a pay stub to apply. Particularly for lines of credit, lenders might want to see a minimum household income of $35,000 to $50,000. Personal loan lenders, especially alternate lenders, can be more flexible about income requirements, though you will likely still have to verify your income.
Credit check
Whether you’re applying for a personal loan or a line of credit, most lenders will likely conduct a credit check to review your credit history and assess your credit score. This step helps them gauge how reliable you are as a borrower.
Credit scores of 660 or higher are typically considered favorable, indicating good creditworthiness. However, the higher your score, the more likely you are to secure approval and receive more favorable interest rates. Enhancing your credit score significantly increases your chances of getting the green light for any loan or line of credit you apply for. In essence, a healthy credit score is like a passport to smoother approvals and better borrowing terms, making lenders more confident in your ability to repay what you borrow.
Mostly issued by financial institutions
Typically, you will find lines of credit and personal loans available through established financial entities such as banks and credit unions across Canada. These traditional institutions are the main sources for these borrowing options. However, there are also other lenders like payday loan providers who are not tied to major banks, offering personal loans. Yet, it is important to note that these alternative lenders might charge higher interest rates and fees compared to what you would encounter with traditional banks and credit unions. It is like having different tiers of options for borrowing money: you have well-known banks and credit unions offering loans, but there are also alternative lenders, like payday loan companies, that might come with higher costs attached.
Personal loan vs. line of credit
While personal loans and lines of credit are both borrowing methods, these differ in terms of how and when you access the funds and accrue interest, typical uses, and more.
Interest rate
When it comes to interest, both personal loans and lines of credit involve varying rates.
With a line of credit, interest is charged solely on the amount you withdraw, not on the total sum available. You have the flexibility to repay what you’ve borrowed at any time, stopping the interest from accruing. Making minimum monthly payments generally covers the interest due.
In contrast, a personal loan charges interest on the entire loan amount, not just what you use. You commit to a fixed repayment schedule, making regular payments that cover both interest and a portion of the loan principal over the loan term.
Typical uses
A personal loan is usually taken out for a specific purpose, meaning you know exactly what you will use the money for—like buying a car or remodeling your home. On the other hand, a line of credit offers a more flexible approach; it is like having a financial safety net. You can access funds without having a set plan for how to spend them. This flexibility makes a line of credit great for unexpected costs or as a backup for emergencies, especially if you are still in the process of building up your emergency savings.
There are no strict restrictions on what you can buy with either a line of credit or a personal loan. However, lines of credit work well for ongoing or smaller expenses because you only pay interest on the amount you use. Meanwhile, personal loans are better suited for significant, one-time expenses where you know the exact amount you need upfront and prefer a structured repayment plan. It is like having different tools: a line of credit acts as a versatile, adaptable option for various smaller needs, while a personal loan is like a dedicated tool for larger, specific expenses.
When it comes to personal loans, there are various types available. One common type is a debt consolidation loan, which offers a reasonable interest rate. People often use this loan to pay off higher-interest debts, like credit card balances. The main idea is to make repayment simpler by combining multiple debts into a single loan, saving money through a lower overall interest rate.
Another type is an unsecured loan, which stands in contrast to a secured loan. With an unsecured loan, you don’t need to provide any collateral, such as your house or car, as security against non-payment. Instead, your commitment to repay the loan is backed by your signature, earning it the nickname “signature loan.” This type of loan relies solely on your promise to repay, without putting any of your assets at risk. It’s like getting a loan based on your trustworthiness and creditworthiness rather than offering something valuable as collateral.