The Difference Between Credit Cards, Personal Loans, and a Personal Line of Credit

The Difference Between Credit Cards, Personal Loans, and a Personal Line of Credit

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Most people know how credit cards work, and they might be familiar with personal loans, too—but what about a personal line of credit? All these options are similar, but they have subtle differences that can affect which one you might choose when you need to borrow money. Here’s a look at when you’d use a line of credit over a credit card or personal loan.

What’s a personal line of credit?

Personal lines of credit are open-ended loans that allow a borrower to withdraw funds as needed, over a fixed period of time, for limits that range from $1,000 to $100,000. Unlike a personal loan, this type of credit lets access funds multiple times rather than getting the money upfront as a lump sum. Interest accrues once funds are withdrawn, with borrowers making minimum monthly payments like a credit card.

Personal lines of credit are typically unsecured (which means that your property isn’t used as collateral) and have a variable annual percentage rate (APR) that’s based on your credit score (again, like credit cards). While the interest rates for both lines of credit and personal loans can be in the 6-35% range, lines of credit tend to have slightly higher rates. Another distinction is that personal loans typically have fixed rates, while lines of credit tend to have variable rates. That said, both options offer interest rates that are cheaper than what you’d get with credit cards—typically about 16% APR on average.

Why would you use a personal line of credit?

For the flexibility. Lines of credit are more open-ended than personal loans, and tend to be used for ongoing needs where you don’t have a fixed cost in mind. Personal loans, on the other hand, offer a fixed amount of funds in advance, and to qualify, you often have to state exactly what the loan is for, whether that’s for a home renovation or auto repairs.

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Of course, the flexibility offered by a personal line of credit makes them potential debt traps. That’s why a solid plan for repayment is recommended. Some common scenarios in which a line of credit might be used includes:

Home renovations in which cost overruns might be a concernShort-term medical expensesAs a financial bridge when there’s irregular or seasonal work

As for credit cards, they offer cash back rewards and tend to have higher interest rates compared to personal loans or lines of credit, so they’re better suited for daily purchases that can be paid off quickly. If you’re looking to fund expensive, long-term projects that you plan to pay off later, avoid credit cards and stick to personal loans or lines of credit.

Otherwise, avoid borrowing credit if you can’t afford to pay back. And if you’re already struggling to pay off debts, consider all of your options before signing up for more credit (this Lifehacker post has you covered).

 

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