When there's a money crunch, it can be a challenge to take your time and evaluate all your options. You might be debating between accessing a line of credit or getting a personal loan. Both types of debt have pros and cons, so one is not necessarily better than the other. The best option depends on your personal financial situation and needs.
Personal Loan and Credit Line Basics
A personal loan is a standard loan that you take out with a bank or some other financial institution. With a personal loan, you get a fixed amount of money in a lump sum and pay the money back over time through monthly payments. Many personal loans come with fixed interest rates, so the monthly payments stay the same for the life of the loan. A personal line of credit is similar to a credit card: a lender sets a limit for the credit line and you can borrow money in small amounts as you need it up to the limit.
Advantages of Loans
One of the major advantages of a normal loan is that you know exactly how much you are borrowing from the start and, with a fixed interest rate, you know exactly how much you have to pay each month. Credit lines usually come with variable interest rates, so you can't be sure how much interest you will actually pay. Since credit lines let you borrow a little bit at a time, they make it easy to accrue debt and increase the amount you owe each month. Loans are predictable and can help you avoid the temptation of borrowing too much.
Advantages of Credit Lines
Despite their drawbacks, credit lines offer some advantages over loans that can make them more attractive in certain situations. For example, if you only need to borrow a small amount currently, but you might have to borrow again in the future, a credit line gives you the flexibility to borrow money as you need it. Even though credit lines have variable interest rates, the amount of interest you end up paying may be lower than what you pay on a personal loan, especially if interest rates fall over time.
Home Equity Loans and HELOCs
If you own a home, home equity loans and home equity lines of credit (HELOCs) are alternatives to personal loans and credit lines. With home equity debt, you use the equity you have built up in your home as collateral for the debt, which can grant you a lower interest. Home equity loans and HELOCs are essentially second mortgages: when you borrow against the equity of your home you trade away some of your ownership interest in the home. It can be painful to trade away home equity that you’ve worked hard to build, but lower interest rates can make home equity loans and HELOCs cheaper than personal loans and credit lines.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.