Differences Between Personal Installment Loans and Lines of CreditPublished on March 19, 2021 by Daniel Azzoli
There comes a time in the lives of many Americans when they find themselves in need of some extra cash. Whether they’re trying to make a big purchase like buying a house, or they need some extra funds to handle a short-term emergency expense that needs to be dealt with right away, they may find that the only way to get their hands on the money they need is by applying for a personal loan.
If you find yourself in this situation, one of the most important things you’ll need to decide is what borrowing option is best suited to your particular situation. The tricky thing here is that if you’re not familiar with the world of financial products, navigating through all of the potential options can feel overwhelming. It’s up to you to do your research or speak to a financial advisor to get yourself up to speed.
If you’re new to borrowing money, it might help to start by learning more about some common categories of loans. Two important ones to start with are personal installment loans and lines of credit. You may already have some idea of how a typical loan works. Generally, you’ll apply and if approved, you’ll receive a lump sum that you’ll need to pay back over a certain period of time depending on the type of personal loan.
A personal line of credit will have some similarities to the type of loan described above, but also has some unique qualities that may be better suited to different types of needs. If you need some additional funds for any particular reason, you’ll want to understand the differences between a line of credit and other types of loans. Today, we’re going to take a look at installment loans and lines of credit, go over their similarities and differences, and help you to get a better idea of which may be suited to your situation.
What is an Installment Loan?
When you think of what a loan is, there’s a good chance that an installment loan is at least similar to what you’re picturing. And because a lot of different types of loans fall under the umbrella of installment loans, there’s also a chance that you’re more familiar with them than you may have thought. They can include things like mortgages, student loans, auto loans, and more.
If you’re approved for an installment loan, you’ll be given a lump sum which you’ll need to pay back in fixed, scheduled installments. These payments will generally be comprised of a portion of your principal balance (the amount you borrowed), interest, and/or certain other fees, depending on the financial institution and the type of loan. These payments can be spread out over a few months, or even several years.
Secured vs. Unsecured Installment Loans
An important distinction to make between different types of personal installment loans is whether they’re secured or unsecured. In order to qualify for a secured loan, you’ll need to provide some sort of assurance that the financial institution you’re borrowing from will get some type of compensation even if you aren’t able to make your payments. This assurance comes in the form of collateral. The type of collateral you’ll need to provide can vary depending on the type of loan and the financial institution. For example, in order to qualify for a mortgage (which is considered a secured installment loan), the collateral you’d be providing would be your equity in the house you’re buying.
With an unsecured loan on the other hand, you won’t need to provide collateral to qualify. This does come with some caveats though. Because the financial institution isn’t guaranteed to get some form of payment from you if you default on your loan, the interest rates tend to be higher for these loans than they are with secured loans.
What is a Line of Credit?
While a line of credit is also a type of personal loan, it has some characteristics that make it unique. Like installment loans, a line of credit is really an umbrella term that a number of different types of lines of credit fall under. This can include home equity lines of credit, business lines of credit, and more.
Essentially, a personal line of credit is a type of loan that gives you the capacity to draw funds from a specific credit limit that’s pre-determined. It functions similarly to a credit card in that if you’re approved, you’ll be given a credit limit that you can’t exceed, but can draw up to that amount whenever you need as long as your account is in good standing and you have available credit.
One of the defining features of a line of credit is that it’s considered to be a type of revolving credit. What this means is that you can draw however much you need (as long it doesn’t exceed your limit), when you need it. So, let’s say you only need an extra $50 to help you pay for an unplanned car repair, you’ll have the ability to get a hold of just that amount instead. It also means that as you pay off what you owe, you can still draw money against your credit limit on a continuous basis. On top of that, when you pay down your line of credit loan, your payments will be based on the amount of credit you’ve used, not the total amount of your credit limit.
Differences Between Personal Installment Loans and Lines of Credit
While some of the differences between installment loans and lines of credit may be apparent after having defined both on their own, some of these differences may be clearer when you hold them up next to one another.
For starters, with an installment loan, your interest will start to build up right from the start, and you’ll need to pay interest and/or other fees on the total balance of the loan. On the other hand, you won’t start paying interest or other charges on a line of credit until you actually request a draw and receive your funds. And like we mentioned earlier, you’ll be paying interest on the amount you’ve drawn, not on your credit limit.
Because a line of credit is a form of revolving credit, it can be a useful thing to have at your disposal when you’re not exactly sure of how much money you’ll need in a given situation. For example, if you’re looking to do a large-scale remodeling of your home, you may not be able to attach an exact number to the cost of the project. In this case, something like a home equity line of credit (HELOC) may be useful to have at the ready.
Having a credit limit at your disposal may not necessarily be the best thing for everyone though. With something like an installment loan, you’ll be limited right from the start as to how much money you can spend. If you think that having an open-ended balance to draw upon could lead you to overspend, a loan that gives you a fixed sum may be preferable. On top of that, having a predictable and scheduled repayment process may be easier for you to plan for in your budget.
Regardless of which type of loan you choose to apply for, all loans can lead to further debt if they’re not managed properly. So before you make any decisions, you should always make sure that you can actually afford the loan you’re thinking of applying for.
Do Your Research Before Applying for a Personal Loan
In the end, the truth of the matter is that there are going to be a lot of individual factors that make your situation unique, and these are the things that should dictate what type of loan you should apply for. For some, the flexibility and open-ended nature of a line of credit may be just what they need, while others may prefer the fixed nature of the repayment process of an installment loan.
Before you make any decisions, start by listing out the benefits and downsides to both types of loans. Do some research and get a better idea of what credit options might be available to you. Once you feel like you’re better educated on the subject, you’ll hopefully have enough information to make a more informed decision. We hope this article is a good jumping-off point for you!