When you face any major expense and are looking for the additional financing required, approaching a bank is one of the first options that come your way. The most commonly offered financing products in such instances is a personal loan or a personal line of credit. While both these products offer us the required financing, they come with their own set of shortfalls. Thus we need to know the differences between the two so that we can choose the option that is more cost effective in the long run.
What is a personal loan?
A personal loan or personal financing is an amount of money you borrow from a bank or any financing company. The bank charges interest on the amount that you have borrowed and you will have to pay it over a designated period of time. The interest rate charged can be flat or variable depending on the scheme.
A personal loan can be secured or unsecured type of financing. Secured type of financing involves keeping your asset (car, house etc.) as guarantee against your financing. Unsecured types of personal loans are lent based on your income and credit score.
In Malaysia, you can obtain a personal loan that operates on both Islamic and conventional banking methods.
What is a line of credit?
Unlike personal loan, a line of credit is a type of loan that does not involve a fixed amount of money. While the line of credit does come with a predetermined ‘credit limit’ at the time of the agreement between a borrower and a lender, the borrower does not have to utilise the entire amount. The borrower is free to utilise as much as they need from the determined credit limit and pay the interest only on the amount utilised and not on the entire credit limit.
Since the lender (bank) does not know when you are borrowing the money, the rate of interest charged will be the prevailing borrowing rates of the bank at the time of the draw thus making the interest rate levied on the amount a variable rate.
Personal lines of credit can come with a commitment fee even on the unutilised amount. This fee can go as high as 1% of the unutilised credit limit.
Personal loan vs line of credit
There are some characteristic differences between a personal loan and a line of credit. You should consider the following pointers before applying for any of the facilities:
- In a personal loan scheme, you will be granted with a fixed amount of money whereas a line of credit offers you a maximum limit from which you can utilise your desired amount.
- A line of credit is suitable for borrowers who need a constant source of additional financing s it allows them to access the funds whenever they need.
- You can save more when you use a line of credit compared to a personal loan scheme. As in a line of credit, interest is charged only when you use funding, and only on the amount utilised. It can be more cost effective provided the bank does not charge a high commitment fee.
- Unlike personal loan which you have to pay via a set regular instalments, a line of credit does not involve any set repayment tenure. There is no amount you need to pay every month provided you are paying the interest charges on the utilised amount.
- Both the facilities require you to have a clean and healthy credit history.
Considering these points, you can see that a personal loan and a line of credit have their own set of benefits and drawbacks. Thus, whenever you are in a financial crunch, you should take into account your requirements and the features of both the facilities carefully before finalising on any one option.