How are Lines of Credit Different from Installment Loans?

Whether you’re on the hunt for a new house and need some financial help, or you’re facing an emergency expense and your savings have run dry, there’s a good chance that at some point in your life, you’ll be in the market for a personal loan. When this time comes, you’ll need to have a good grasp of what your specific needs are and what your overall financial situation looks like. From there, the next step would be to assess your potential options. This can sometimes be easier said than done if you’ve never had any reason to look for a personal loan in the past. It can be tough to sift through the countless financial products out there, with their nuanced innerworkings and their varied use cases. So, if you’re just starting out, it might be best to keep things simple and start by learning about some of the more common, broad categories of loans. Two types that fall under this umbrella are installment loans and lines of credit. Both these types of personal loans can be useful in any number of situations, so it’s important that you have a good understanding of both in order to better assess what might be right for you. So, with that said, we’re going to go over a broad definition of each and talk about some of the ways in which they differ to help increase your knowledge on these types of personal loans.

What is a Line of Credit?

When we talk about both lines of credits and cash installment loans, we should be clear that we’re giving broad definitions of each, as there are different versions of these loans that fall under each umbrella. Having said that, there are still some general traits that virtually all lines of credit are going to have, and that’s what we’ll be focusing on. For starters, a personal line of credit is a kind of revolving credit. This means that you can draw funds from a pre-determined credit limit on a continuous basis, as you pay back what you owe. If you use a credit card on a regular basis, you should have some idea of how this type of credit account works. This type of borrowing option is fairly flexible, as it allows you to choose how much you’re going to draw based on your needs, as long as you have available credit. So, if you’re facing some sort of home repair that’s going to cost you $200, you’ll have the ability to borrow no more or less than you need, assuming you have that much available credit. There are a couple more features of this type of loan that are worth mentioning. When it comes to repayment, you’ll typically need to repay what you’ve borrowed by the end of your billing cycle, which in some cases, could be at the end of the month. Having said that, you’re required to make a minimum payment, which is the minimum amount of money you have to pay in order to keep your account in good standing. Keep in mind that you should do your best to make your payments in full to avoid accruing more debt than you need to. Another important feature about the repayment process is that you’ll be paying interest and/or fees based on the amount of credit you’ve drawn, not the total amount of the line of credit limit.

What is an Installment Loan?

Unlike lines of credit, installment loans have a bit more of a firm structure to them. What does this mean? Well, for starters, if you apply for an installment loan and get approved, you’ll be given a specific lump sum as opposed to getting access to a pool of credit to draw from. Once you receive your funds, interest will start to accrue on what you’ve borrowed. Another structural difference between a line of credit and installment loan is the repayment process. With an installment loan, you’ll have a pre-determined payment schedule laid out for you right at the beginning of the borrowing process. These payments will typically be scheduled on the same day(s) of each month and will be of equal value. They can be spread out over the course of a few months, or even several years in some cases.

Differences Between Secured and Unsecured Installment Loans

While we won’t go over each specific type of installment loan, one key distinction we should make between some of the types of cash installment loans out there is between secured and unsecured installment loans. With a secured installment loan, you’ll need to provide collateral in order to qualify. This collateral will come in the form of a valuable asset which essentially ensures that even if you default on your loan, the lender providing the loan will still recoup some sort of value from the arrangement. The form that this collateral will take is going to depend on the type of loan you’re applying for and the lender that’s providing the loan. While a secured installment loan can seem like a risky venture, the safety net for the lender provided by the collateral you’ve put up means that you’ll typically be able to receive relatively low rates on your loan. As you might have guessed, you won’t need to provide collateral in order to qualify for an unsecured loan. While that means you won’t need to risk an asset, you’ll likely see higher interest rates than you would with a secured loan.

2 Key Differences Between Installment Loans and Lines of Credit

After giving a broad definition of both these types of loans, we can see that there are some obvious differences between the two. Having said that, it’s worth taking a closer look at some of them so we can better understand the situations that one may be more suited to than the other.

1. Interest

When it comes to how interest works with an installment loan, one of the key things to remember is that interest begins to accrue right when you receive your funds. Since you get your funds in a lump sum, the interest and fees you’ll need to pay is calculated on the total loan amount right away. Like we mentioned earlier, with a personal line of credit, interest won’t start to build up until you draw funds from your available credit. The interest you’ll need to pay will be based on whatever amount you’ve drawn.

2. Revolving Credit vs. Lump Sump

One of the benefits of a line of credit is that it’s a fairly flexible borrowing option. This can be a valuable quality when you don’t know exactly how much money you’re going to need in a particular situation. This could be in the case of an emergency situation, or even for a more large-scale project. For example, if you’re doing some sort of extensive home renovation but don’t know how much it’s going to cost you, a home equity line of credit is typically meant for these types of situations. Having said that, having easy access to credit isn’t always going to be a great thing for every person, particularly if you have a penchant for over-spending or mishandling credit. This could lead to excessive debt which can be a tough cycle to get out of. The key is to make sure you’re always using credit responsibly. With an installment loan, whatever amount you get approved for is what you get, you won’t have the option to continuously tap into more funds. In addition to this, the fixed nature of the repayment schedule can make it a little easier to plan your budget around your loan repayments. With a line of credit, you’ll still have a fixed due date but have more agency in terms of the amounts you draw.

Consider your Options Carefully

When it comes down to it, there’s no universal answer as to what loan is going to be the best option for every person. Ultimately, it’s going to come down to the nature of your financial situation, what your needs are, and all sorts of other factors. These are some of the things that should determine the kind of loan that you’re considering applying for. In some cases, you might value the flexibility that a personal line of credit offers, while in other instances, you may find comfort in knowing the fixed repayment amounts of an installment loan. Whether you feel like a line of credit or installment loan is more up your alley, you should always remember that if you don’t properly manage the borrowing process, you can get yourself into some serious financial hot water. So, before you decide what loan to apply for, make sure you have a clear idea of what you’re getting yourself into. List out some of the pros and cons of each loan, evaluate your situation, see what options may be out there, and always make sure you can afford to repay what you’ve borrowed. Stay informed and put yourself in the best position possible to make the right choice for your situation!