Looking into your credit options to help with an important purchase? Or interested in exploring how a rewards credit card could make your money go further, but unsure where to start? It helps to have a good understanding of the differences between personal loans, lines of credit, and credit cards to help you figure out which option might work best for you.
Lines of credit and personal loans have similarities, but there are a few differences that are worth knowing before you think about applying for either option. A personal loan is a fixed amount that you agree to borrow from a bank or financial institution, usually over a fixed period of time. This option could work for you if regular monthly repayments and a pre-agreed rate of interest on the amount you borrow suit your financial needs and situation.
"A loan is for a specific amount of money, and it typically comes with a payment schedule and equal payments for a certain term. Personal loans are normally unsecured, meaning they are not secured against an asset. Other loans can be secured, as with a car loan or mortgage," says personal finance writer for NerdWallet, Bev O’Shea.
A line of credit differs in that it allows customers to borrow a specified amount of money that can be used if and when it’s needed. You can draw on funds up to a certain agreed limit, but the borrower is not obligated to make use of the full amount that the bank is willing to lend.
Like loans, lines of credit still need to be paid off either immediately or over a specified time period. But unlike a one-time personal loan, they can be renewable, meaning users may be able to re-use their line of credit as they repay. Monthly payments are based on the amount of the line of credit you actually use, rather than the total amount that is available to use.
Credit cards allow you to borrow money up to an agreed limit with a variable or non-variable interest rate. If you use your credit card to make purchases and you pay your balance in full by the payment due date each month , and if the card issuer provides a grace period on purchases, then you may not have to pay interest on the amount you have spent on purchases. Otherwise, you may need to pay interest on top of what you have borrowed, which will differ depending on the rate of your card.
Credit cards are also different in that many of them offer rewards, meaning they can provide benefits such the ability to earn rewards points, cash back, or airline miles every time you use the credit card to make purchases. To learn more about rewards credit cards, and how they could work for you, read Can the Right Cash Back or Rewards Credit Card Help You Save Money?
Doing your research before you apply can save time in the long run. For personal loans and lines of credit, contacting your bank can be a good place to start because they can talk you through terms such as the loan amount and the interest rate, and some banks only offer lines of credit and loans to existing customers. For personal loans, if you know how much you would like to borrow, you may also be able to apply online with your bank, depending on the amount.
Similarly, for credit cards, the application can be completed online, by either going directly to the bank or lender’s site offering the card you are interested in, or by looking for a card that fits your particular needs through a price comparison site. "It’s also smart to have an idea of what your credit score is, and to understand how that could factor into your likelihood for approval," O’Shea adds.
If you’re interested in applying for a credit card but aren’t sure which one might be right for you, read 5 Questions to Ask Before Getting Your First Credit Card for some helpful tips.
There isn’t just one answer for what kind of credit option could work for you, because your decision will likely depend on your spending habits, lifestyle, and credit history.
"Credit cards are good for someone who might want a card to use for everyday transactions or some larger purchases, and may want the additional convenience of using a card. Ideally, this person should be able to pay off credit card purchases each month. If earning points and miles is a priority, then a credit card makes better sense," says financial planner at Earn Into Wealth, Kaya Ladejobi.
"Personal loans could work for someone who needs an amount of money upfront to complete a larger financial transaction, while a line of credit might work for someone who needs access to a larger amount of money and continuous access over a specified period of time. It also might be a solution for someone who doesn’t need to use all of the funds available right away," Ladejobi adds.
It’s important to take some time to understand your credit health and what credit option might suit your lifestyle. When considering which one could work best for you, start with your bank’s website or visit a branch to learn more. For more details on credit reports, see How to Help Build Credit.