What are the differences between a line of credit and a loan?
If you need funds to carry out a project or pay for unexpected expenses, you can take out a line of credit or a loan. Depending on your situation, one of these financing solutions is probably better suited to your needs. Here are the main differences:
What’s a personal loan?
A personal loan is a consumer credit that you can spend as you wish. You could, for example, choose this type of financing to carry out renovations or pay for a trip.
Characteristics of a personal loan:
- A predetermined amount: Depending on your needs and financial capacity, you can generally borrow a minimum of $5,000 or more (amounts may vary from one financial institution to another).
- Different term options: Depending on your situation and financial institution, your monthly payments could be spread over 6 to 60 months.
- A fixed or variable interest rate: Depending on your risk tolerance, you can choose whether or not your interest rate fluctuates with the market. In either case, your payments will be equal. But keep in mind that if you opt for a variable rate and your payments aren’t sufficient to repay the interest, a final lump-sum payment may be required.
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The advantage of personal loans:
- Attractive interest rates: A personal loan usually offers better terms than a credit card.
The disadvantages of personal loans:
- More rigid conditions: Personal loans have start and end dates between which you have to make predetermined payments. Once the loan has been repaid, you’ll no longer have access to this credit.
- A potentially more expensive solution: The interest rates you’ll get with a personal loan may be higher than those offered by another financing option, such as a mortgage.
What’s a personal line of credit?
Personal lines of credit have a predefined credit limit. Once you’ve been granted a personal line of credit, you can access these funds via your online banking and over-the-counter services. Unlike a personal loan, you have more flexibility in repaying it.
The characteristics of a personal line of credit:
- Pre-authorized funds: You can withdraw funds up to the agreed limit without having to go through the credit authorization process again.
- Minimum payments: Until your line of credit is fully repaid, you need to make monthly payments equivalent to the interest rate on the balance used. Management and transaction fees may also apply.
- A variable interest rate: The interest, which is calculated based on the bank’s prime rate and a spread determined by risk tolerance, follows market fluctuations.
The advantages of personal lines of credit:
- Flexible repayment terms: You can use your personal line of credit for any type of purchase and repay it at your own pace, as long as you make the minimum monthly payments.
- Attractive interest rates: A line of credit generally offers a lower interest rate than other financing options, allowing you to repay it more quickly.
The disadvantages of personal lines of credit:
- A risk of over-indebtedness: The availability of these funds could lead you to spend excessively and, if you delay repaying your balance, the interest charged will increase the total amount you have to pay.
Learn more
There are different types of
lines of credit. Check out our articles to learn more:
→ What
to know about lines of credit
→ How
does a home equity line of credit work?
Should you choose a line of credit or a loan?
If you’re hesitating between these two financing solutions, take the time to consider which one is best suited to your personal and financial situation. Before making a decision, ask yourself the following questions:
Do you have a good risk tolerance?
Since personal lines of credit typically have variable interest rates, expect your monthly payments to fluctuate according to the market – and on how much you use it. Would you prefer to know in advance what your minimum payments will be? You might have more peace of mind with a fixed-rate personal loan.
What are your financial needs?
Do you need a set amount to buy a car or carry out renovation work? A personal loan is ideal for specific projects. But if you’re looking for funds for unexpected expenses or short-term needs, a line of credit offers greater flexibility. You can borrow money quickly, repay your line of credit and then take out new loans as you need them.
Do you manage your finances well?
If you’re disciplined about paying off your debt, you could opt for a personal line of credit. However, if you need a little more guidance, a personal loan is a better choice. The advantage of this financial product is that it stipulates that you repay your loan within a set period of time, which forces you to be more disciplined with your payments.
How can you manage your credit effectively?
Whether you opt for a line of credit or a loan, it’s always a good idea to adopt sound financial habits. Here are a few tips to optimize your borrowing and avoid falling into the debt trap:
- Not sure how much money you’ll need to complete your project? You may be better off taking out a personal line of credit. You’ll only pay interest on the sums paid out and will always have the option of borrowing more if necessary.
- If you opt for a personal line of credit, set yourself a repayment plan that respects your financial situation, and follow it rigorously.
- A line of credit or a loan can help you pay off your other debt more quickly. Make sure you prioritize paying off loans with higher interest rates. For example, if your line of credit has an interest rate of 12%, you should pay off your credit card debt at 19.99% and wait to pay off your car loan at 8%.
Remember that choosing between a line of credit and a loan depends on your financial needs, your risk tolerance and your ability to manage repayments. If you’re still undecided between these two financing products, talk to your financial advisor.