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What is a Personal Line of Credit?

What is a Personal Line of Credit?

If you are thinking of choosing between availing a personal loan or a personal line of credit, then you should know the following factors, which will help you decide.
Aparna Iyer
People have the option of securing a personal loan or a personal line of credit for the purpose of making home improvements, consolidating bills, paying medical expenses or paying for college tuition. In the following paragraphs, we tell you the difference between about these, and which one of them will be better suited to you.

Personal Loan
Personal loans are different from commercial loans, and are classified as secured or unsecured loans. Unsecured personal loans are also referred to as signature loans. While secured personal loans are backed by a collateral, signature loans are not secured by an asset.

In order to avail a personal signature loan, the borrower is expected to have a good credit history. Moreover, a steady source of income, that would guarantee the creditor of receiving regular principal and interest payments, is also a must. This is because unsecured personal loans are not backed by a collateral. Hence, the creditor cannot hope to seize the collateral and recover his/her money in case the borrower defaults. An unsecured personal loan is much riskier from the perspective of the lender, since recovery is contingent to the borrower's willingness and ability to repay the loan. Hence, credit history and credit rating become very important from the perspective of obtaining an unsecured personal loan. People with poor or bad credit may try and avail bad credit personal signature loans.

Secured personal loans are backed by a collateral. Hence, the creditor is assured of recovering the money that is lent, either in the form of principal and interest payment, or by repossessing the asset in lieu of defaulted payments. Although a good credit rating helps the borrower avail a secured loan at a favorable rate of interest, a poor rating may not disqualify the borrower from obtaining the loan.

Personal Line of Credit
Personal lines of credit allow consumers to establish a relationship with a lending institution, which encourages them to borrow money as and when required, for meeting expenses that people may have to incur on an ongoing basis. Like personal loans, a personal line of credit can be secured or unsecured. One needs to have a really good credit score and credit history to avail these. For those who are familiar with Home Equity Lines of Credit (HELOC), a secured line of credit is similar to a Home Equity Line of Credit. Unsecured personal lines of credit are also similar to HELOCs except for the fact that an unsecured personal line of credit is not backed by a collateral while a HELOC is backed by the home which may be seized by the lender if the borrower is unable to repay the borrowed sum. Another significant point of difference between the two is that, the interest rate on personal lines of credit is higher than that on HELOCs.

Choosing Between The Two

Borrowed Sum
A secured personal loan allows a person to borrow between USD 3,000 and USD 250,000; while in case of an unsecured personal loan, one may borrow between USD 3,000 and USD 100,000. A secured personal line of credit allows a person to borrow between USD 10,000 and USD 250,000; while an unsecured line of credit allows the consumer to borrow between USD 5,000 and USD 100,000.

Payments
A line of credit allows people to pay interest that is based on the prime rate of interest and is thus variable. The monthly payments may be as low as 1/20th of the outstanding principal and accrued interest. There are no penalties for prepayment and people are encouraged to repay the principal whenever possible. In case of a personal loan, people are required to make fixed monthly payments consisting of the interest and the principal component.

Repayment Period
Secured personal loans have to be repaid within 10 years, while unsecured personal loans have to be repaid within 5 years. Technically, there is no repayment period for a personal line of credit since it is revolving. However, people are encouraged to repay within 12 to 18 months.

The choice of whether to borrow a personal loan or a personal line of credit depends on the borrowers willingness and ability to repay the borrowed sum. People who are sure of their ability to discharge personal obligations by making fixed monthly payments, borrow personal loans. Consumers, who are unsure of their ability to discharge fixed and regular monthly payments, prefer personal lines of credit since the rate of interest on the debt obligation is variable and the borrower is required to discharge only the minimum interest payments, like in case of a credit card.