At some point in our lives, most of us will take up a loan to pay for a major purchase. The go-to party in this case would be financial institutions like banks that make most of their income by lending money, issuing personal loans or lines of credit (LOC). Both personal loans and line of credits have its advantages and disadvantages. Depending on your situation, one might be more cost-effective in the long run. Hence getting to know the differences between these two options is important.
What is a Personal Loan
A personal loan is basically a lump-sum amount of money that you borrow from a bank or any other financial institution. With a personal loan, you pay an interest rate on your principal (the initial amount you borrow). The interest is paid over a period of time, depending on your arrangement with the lender. This interest rate can either be fixed or variable, based on your preference.
A personal loan does give a sense of certainty to the borrower as you are aware of the total amount you are borrowing, the monthly payment that comes with it, and the term of the loan.
What is a Line of Credit
A line of credit on the other hand is a type of loan that does not come with a fixed amount. Based on your agreement with the bank, the lender and you would agree on the maximum amount of money you can borrow, which in this case is known as your "credit limit". Flexibility is an advantage that comes with taking up a line of credit. Take for example; you might agree on a RM20,000 credit facility with the bank, but at any given time, you can withdraw any amount below or up to RM20,000. You can access your line of credit by issuing checks.
As lenders do not know when you are actually borrowing the money, most of them would charge you based on the interest rate at the time of your borrowings (or also known as the 'draw'). This makes the interest rate on a line of credit variable. You only pay interest based on what you've borrowed and not the entire credit limit. So, if you borrow nothing during the entire arrangement, you pay nothing except for some fees that the bank may charge, like maintenance fee. This flexibility is suitable for those who have varying needs and are making on-going purchases. As interest rates change from time to time, you may end up paying a lower interest rate than a personal loan.