In a financial emergency, you have two major options. You can borrow a personal loan or take out a line of credit.
But what does it really mean to choose one over the other? Let’s look at the difference between these financial products, so you can make an informed borrowing decision.
Difference #1: How Lenders Calculate and Apply Interest
Interest is always an added cost of borrowing money, no matter how you do it. However, interest changes depending on the financial product you choose.
When it comes to an installment loan, you will receive a pre-determined amount upfront as one lump sum. Your lender will apply interest and other finance charges to this entire sum, regardless of how you spend it. Each payment you make will cover a portion of these fees.
Things change with a line of credit because you are given a credit limit, which represents the total amount you can borrow at once.
A lender like Fora gives you the option to use your entire limit in one withdrawal to cover a single unexpected expense. Alternatively, you have the freedom to make several draws against your Fora Credit account when and if you need it, as long as there is credit still available.
Why does this distinction matter? Fora, like other lenders, will apply interest and finance charges on what you use — not your total limit.
Difference #2: The Minimum Payment
The minimum payment refers to the least amount of money you have to pay to keep your lender happy. How this minimum works differs greatly from loans to lines of credit.
The minimum on your installment loan is often the pre-determined payment that your lender arranges when you first accept their offer of financing. In many cases, this is a fixed payment amount that remains the same each due date for the lifespan of your loan.
A line of credit’s minimum payment is a small fraction of your overall balance. It usually covers a small portion of your principal plus interest and finance charges. That means it changes depending on how you use your account.
Paying this minimum keeps late payments off your record, but it won’t erase your full balance. The difference will carry over into the next statement, where it will tie up your limit and accrue additional charges.
Difference #3: The Account’s Lifespan
A personal loan is best used in emergency situations where you only have to pay one bill. That’s because it’s a closed-ended product. Once you pay back the last cent to your lender, the account closes, and you won’t have access to your funds again.
What happens if you run into trouble months later? You’ll have to reapply for a new personal loan.
The same isn’t true for a line of credit. As an open-ended or revolving account, it stays open for as long as you pay your minimum. You can tap into the remaining credit any time it’s available without filling out an application for a new line of credit. If you pay off your full balance, you can borrow up to the full credit limit without reapplying.
Did This Help?
Now that you know how each financial product is unique, you’re in a better position to choose which one is better for your needs.
