Line of credit vs. loan: Which is best for you?

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In a Nutshell

If you’re looking for financing options, you’re probably considering a loan. But a personal line of credit could be a better option in a handful of circumstances.
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A line of credit works differently than a loan but may be a great alternative when you need funds on an ongoing basis.

You’re probably familiar with how a loan works: Once your loan application is approved, you receive the loan as a lump sum. You’re typically required to start making at least minimum payments soon after and will pay interest on the money you’ve borrowed right away.

Lines of credit share some common qualities with loans but offer a different way to access cash and repay balances. If you’re deciding between a line of credit and a loan, those differences are important to understand.

Personal line of credit vs. personal loan

With a personal loan, you’ll begin accruing interest on the full loan balance right away and will be responsible for making fixed payments over a set period of time. With a line of credit, however, you won’t have to pay interest until you draw on the line, and you’ll only be charged interest on the outstanding balance you carry.

Having a line of credit means having access to funds you can use and repay over and over again within a certain time frame. This can be handy when it comes to big projects like a home remodel, where expected costs can shift. It could rid you of the hassle of having to find an extra source of cash when costs come up down the line.

You may, however, find it difficult to qualify for a line of credit of your choice if you don’t have the best credit, since lenders will consider your income, current credit level of debt with other financial institutions and your credit report when evaluating applicants.

If your credit is less than stellar, you may be able to find a personal loan you qualify for — just know that lower scores could mean higher interest rates.

Loans may be a better alternative for a number of other reasons too. They allow you to limit what you borrow to the amount you need upfront, rather than have an open balance you can draw on. And they offer the predictability of required regular monthly payments that you can budget for.

But debt could build up for both lines of credit and loans if you’re tempted to make just the minimum required payments while letting interest build. So before considering either option, make sure you’ll be able to repay the funds as agreed.

When to consider applying for a personal line of credit

  • You’re not sure how much money you’ll need
  • Your expenses may be spread out over a period of years
  • Your credit is in good condition

When to consider applying for a personal loan

  • You know how much you need to borrow
  • You want to limit the amount of debt you take on

Bottom line

Choosing the right fit between a loan and a line of credit is important. Taking out one when the other is the better option could end up costing you more in the end.

Before applying for a loan or a line of credit, it’s important to consider how much financing you’ll need in the long and short term, as well as the condition of your credit, to help make the best decision for you.

About the author: Sarah C. Brady is a San Francisco-based financial consultant, workshop facilitator and writer. In addition to writing for Credit Karma, Sarah writes for Experian, LendingTree, Magnify Money, MSN News and more. In her … Read more.