Personal Loans Versus Lines of Credit: Which One is Best? (2024)
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Discover the methodologyWhen you need money in Canada, you have lots of borrowing options. It can be hard to pick between the many types of personal loans, lines of credit and credit cards.
The reality is that everyone has different needs. With that in mind, we explore personal loans and lines of credit. Are you deciding between a personal loan vs a line of credit? We have you covered. We examine how each one works, how to apply for them and which might be right for you.
What is a personal loan?
A personal loan is a popular way of borrowing. You get a lump sum upfront and make fixed monthly payments throughout the loan term to pay it back. They are designed for one-time expenses. Repayment amounts generally remain the same each month because they have fixed interest rates and fixed term lengths. Local banks, online lenders and credit unions all offer personal loans.
Personal loans can go towards large purchases, paying off student loans, covering wedding expenses or paying off credit card debt.
Pros and cons of a personal loan
No matter the type of debt product you choose, they all have benefits and drawbacks. Let’s take a quick look at the pros and cons of personal loans.
Pros
- Lump sum amount
- Quick approval
- Low-interest rates
- No requirement for collateral
- Can be used for multiple purposes.
- Convenient to manage
Cons
- Stringent eligibility requirements
- Higher payments than credit cards
- Fees can be high
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What is a line of credit?
A personal line of credit is a flexible option when you are unsure how much money you need. It is similar to a credit card, except without a physical card.
They are revolving credit lines with a borrowing limit and a flexible interest rate. This is the major difference between a line of credit and a personal loan. They may be a good option if you are unsure exactly how much you need. It is often used for emergencies, home improvement, managing irregular incomes and overdraft protection. There are different types of lines of credit, but HELOCs, or home-equity lines of credit, are one of the more common. Others include:
- Secured lines of credit
- Unsecured lines of credit
- Personal lines of credit
- Business lines of credit
- Student lines of credit.
Online lenders, banks, credit unions and others all offer lines of credit.
Expert advice
The biggest advantage of a personal line of credit is the flexibility in how you repay it. Just remember that still have to make the minimum monthly payments including interest.
How does a line of credit work?
Repaying a line of credit is a lot like repaying a credit card. You have to pay interest only on the part of the credit you use. Payment amounts change due to the variable interest rate and changing balance.
Lines of credit have both draw and repayment periods.
- Draw periods: you can withdraw money during the draw period. You may not be required to pay back the balance during this time, outside of interest. If you do pay it back, you can continue borrowing up to the unused amount. Imagine a credit card with a $35,000 limit.
- Repayment period:The repayment period starts if you carry a balance when the draw period ends. During this time, you have to make monthly installments to repay the balance. You may no longer be able to make withdrawals.
Pros and cons of a line of credit
A line of credit might seem like a great option, but it is worth considering the pros and cons before you proceed.
Pros
- Flexibility: funds when you need them
- Great for an emergency
- Secured lines of credit have low interest rates
- Lower interest rates than credit cards
- Pay interest only on the amount borrowed
- Convenient repayment options
Cons
- The interest rates could rise over time
- More stringent qualification requirements
- May lead to over-borrowing
- Annual maintenance fees and/or service fees
What is the difference between a line of credit and a loan?
There are some important differences to weigh between loans and lines of credits. To help you decide which one is for you, let's take a look:
Distribution of funds: How you receive and repay the funds is a key difference. A personal loan will give you the full amount upfront. You pay it back in even monthly installments over the term. On the other hand, a line of credit is a revolving credit line. You may use all of it but can choose to tap into less. Use just how much you need when you need it. You pay back only what you actually borrow. You have the flexibility to pay more or less back, like a credit card. But be aware that you usually have minimum monthly payments.
Interest rates: A personal loan often has a lower interest rate compared to a line of credit. Interest is usually fixed, but may occasionally be variable. The interest rate on a line of credit, however, is usually variable.
Qualifying: It helps to understand the qualification criteria for a personal line of credit vs a personal loan. You might find it difficult to qualify for a line of credit if you do not have good credit. However, even with bad credit, a personal loan is usually available. Just remember that a lower score usually means high-interest rates or need to go with a secured loan.
Is a line of credit better than a loan?
Let us take a quick look at how a personal loan versus a line of credit differ to help you decide which is best for you.
| Borrowing option | Personal loan | Line of Credit |
|---|---|---|
| Loan Type | Receive a lump sum. | A line of credit is revolving. Any amount up to the limit can be used at any time. |
| Amount | The loan amount is fixed. | The amount can be variable and can be used for any purpose. |
| Interest | Interest applies on the full amount. | Interest accrues only on the amount of funds used. |
| Interest rates | The interest rate is usually fixed, but variable options exist. | The interest rate is usually variable. |
| Repayment terms | Fixed regular payments | Flexible - pay only the amount you borrow. During the draw period you may only owe interest |
Ultimately, both personal loans and lines of credit can be great resources.
Expert advice
Before borrowing, consider how much you need to borrow and your ability to pay it back. If you value flexibility a line of credit may be right for you. If you're comfortable with fixed monthly payments and want a lump sum upfront, go for a personal loan.
Who should pick a personal loan?
Individuals who need a lump sum of money and who can manage the monthly repayments may prefer a personal loan. It is ideal for:
- Those who need immediate funds. There are several online lenders available who can offer a personal loan in just hours. Traditional banks and credit unions may take a few days.
- Borrowers who need funds for specific expenses. You know how much you need and how you want to use it. For example, if you need funds to pay for a wedding venue, a personal loan could be a good choice since you know the amount needed and how you want to use it.
- Those who have a solid credit score. With a high credit score, you may enjoy low interest on the loan.
A personal loan is not suitable for everyone. It helps to consider your use case and preferences before applying for one. Let's look at an example
For example
Francesa is 38 years old and lives in Chilliwack. She plans to make a once-in-a-lifetime family trip to New Zealand but doesn't have the money saved. She needs about $12,000 for the month-long visit. Because she has good credit, her regular bank is willing to extend her a personal loan at a 6% interest rate. In this case, a personal loan could make good sense. Her monthly payments would work out to $280.95 per month for four years. The total interest would be $1,485.44, which she's willing to pay for the flexibility to travel now.
Who should pick a line of credit?
A loan line of credit is ideal for those who do not know the exact amount of money they need. It is suitable for:
- Those who do not have a specific purpose for the funds. A good candidate for a line of credit is someone undertaking a kitchen renovation where the final cost may be thousands of dollars higher or lower than anticipated.
- Those who seek flexibility in monthly payments. A line of credit does not have a fixed payment to be made each month which gives flexibility and helps manage finances accordingly.
Here's an example of someone who is a good candidate for a line of credit.
For example
Rodrigo is a freelance social media marketer. Because of the nature of his work, his income isn't even. Some months he can bill $10,000, but others are a lot tighter. This uncertainty makes him a big fan of lines of credit. He has had an unsecured one for a long time from his credit union. He values the financial flexibility it affords should he have an unexpected car repair or bill come up during a lean month. He knows that he can afford an emergency and will be able to pay it back at a relatively low interest later.
How do you apply for a personal loan?
Applying for a loan is a simple and quick process. You can compare online lenders and start an application right now:
Get the best personal loan!
There are lots of providers from banks to online lenders. To apply for a loan, you will generally need to provide:
- Proof of identity
- Proof of Canadian residency
- Proof of income or employment
- Canadian bank account.
Once you have the documents ready, you can proceed to apply for the personal loan by following the steps listed below:
- Fill out the online application
- The lender will pre-approve you for a certain amount.
- After the lender agrees to the loan terms and you have negotiated the terms, you will be asked to provide the documents.
- The lender will verify the documents and you will be asked to sign the contract. Double-check the contract before signing.
- You will receive the money in a few days via direct deposit.
How do you apply for a line of credit?
To apply for a line of credit loan in Canada, you need to contact your lender. They ask you to submit documents proving your identity, residence, income and bank account details.
The lender will verify your monthly income and check your credit score before processing the request. The amount, interest rate and borrowing terms will depend on your monthly income, credit score and collateral for a secured line of credit like a HELOC.
Borrow against the equity in your home
Compare HELOCs
Student lines of credit vs student loans
Understanding the difference between a student line of credit and a student loan is important for young borrowers. Both can help pay for your studies but in different ways.
Student loans are a great call for significant expenses like tuition bills or housing costs that you can see coming. They may be available from the federal government, your province or a private lender.
Student lines of credit can be nice to cover irregular costs that are harder to know up front, including books, a car repair or regular living expenses. They are available from private lenders.
Another difference between a student line of credit vs a student loan is the repayment terms. Borrowers often pay nothing back towards a student loan until they receive their degree, but with a student loan line of credit, interest starts accruing immediately.
Both products have their place for students financing their education. Student loans can't be beaten for large amounts. Student lines of credit, though, offer a great backup plan for everyday expenses and surprises.
Car loan vs line of credit
An auto loan provides a lump sum amount to purchase your car. It comes with a fixed interest rate and a repayment period. On the other hand, a line of credit is a revolving option where you can use the money as needed whenever you need it. However, if you are certain that you are borrowing for a car, it is advisable to apply for a car loan. Car loans are secured by the vehicle itself, meaning lower interest rates and an easier application process.
