Personal Loans and Personal Lines of Credit: How to Choose

You need money fast, and you don't want to (or can't) take out a home equity loan. There are a couple of methods of borrowing that fit the bill -- personal loans and personal lines of credit -- and don't require collateral. Which one should you choose?

Personal Loans: Safe and Steady

The personal loan delivers a lump sum and is repaid in installments over a pre-determined period of time. Its interest rate is usually fixed, with equal payments over the life of the loan. Its interest rate is determined by your credit score and the term of the loan, which is the number of years you have to repay it.

Personal loans can be less risky than lines of credit, because their interest rates and payments don't usually change over time. That makes budgeting easier. Another advantage of personal loans is that if you pay as agreed, there's an end in sight -- in one to five years, you'll make that last payment and be free of the debt. Finally, personal loans are considered installment debt, which may be more highly-regarded and more favorably treated by credit scoring systems like FICO.

Personal loans are appropriate when you need a lump sum for a large transaction -- for example to consolidate higher-interest debt, fund an investment or make a big-ticket purchase. They can also be a better choice for those who are uncomfortable with variable interest rates and fluctuating payments.

Personal Lines of Credit: Tops for Flexibility

Personal lines of credit are revolving accounts that function like credit cards -- you can withdraw funds as needed, and your monthly payment is based on your account balance and the loan's interest rate. Personal lines of credit come with variable interest rates, so your payment can increase and decrease over time. You can use and reuse the account during its term.

A personal line of credit is a great choice when you don't intend to use your entire loan amount right away or don't know upfront how much money you will need-- for example, if you're paying college tuition twice a year, funding a series of home improvements over time, or just want a source of emergency cash.

One disadvantage of the personal line of credit is that it has the same potential for abuse as a regular credit card. Because you can use and reuse a personal line of credit, it may be difficult to become debt-free. Chronic over-spenders can find this much too tempting. In addition, if the variable interest rate rises when you're carrying a hefty balance, your payment could increase sharply and cause you financial difficulties.

Credit scoring systems may be less kind to borrowers with personal lines of credit than they are to those who borrow with installment loans. It really depends on your mix of credit and the way the account is reported to the bureaus. If all of your debts are credit card balances, adding another revolving account could hurt your credit score. If, however, you already have an auto loan and a mortgage, throwing a revolving account into your mix probably won't hurt.

It's Personal

The right type of unsecured borrowing depends on your current mix of credit, tolerance for risk and the use to which you'll put the money. Your loan should solve your unique problem in the best way -- and that makes this decision truly personal.

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