Understanding the difference between Personal Loan and Line of Credit

By admin | Jun 11, 2020

When making financial decisions it is important to make an informed decision and examine your financial options when you’re facing difficult circumstances. Today, we’re going to discuss the differences between two financial options:

  • Personal Loan 

  • Line of Credit

While both these options serve the purpose of putting extra money in your hands, they are very different from one another. For you to select either a personal loan or line of credit, it is crucial to understand their differences. 

 

Personal Loan:

All of us know what a loan is. You borrow an amount which you agree to pay in pre-specified amounts, in fixed intervals, for a given tenure. A personal loan doesn’t have a pre-defined purpose and is usually without collateral. Applying for and availing the loan is a single process. 

 

Line of Credit:

A line of credit is similar to a personal loan in the sense that it generally does not have a pre-defined purpose. But, the key difference from a loan is that when you apply for a line of credit and once it is approved, you do not have to immediately avail it. You can avail a portion of your total approved line of credit multiple times as long as the total outstanding amount is within the total approved credit limit. And you pay interest for only the amount availed.

 

Let’s see how a line of credit works with this very simple example:

  1. Let’s equate a line of credit to a pot of money with your name on it. 

  2. This pot of money contains a total sum of Rs 50,000. 

  3. You want to purchase a phone of Rs 15,000, so you remove Rs 15,000 from the pot of money to buy the phone. 

  4.  After taking the Rs 15,000 you still have a balance of Rs 35,000 in the pot that you can use whenever you want.

  5. When you repay your Rs. 15,000, assuming you haven’t taken any other loans, you’ll once again have Rs. 50,000 in your pot.

 

That is the simple mechanism of a line of credit, where you are allocated a total sum or credit limit that you can access at any given time. 

When it comes to paying EMIs, it will only be on the amount that you have used (i.e Rs 15,000 in this case) and not on the whole sum (Rs 50,000). If you haven’t used any money from the sum allocated to you, then you will not be charged any interest on it. 

 

Here are some advantages a line of credit has over a personal loan:

 

Pay interest on only what you avail:

A personal loan, once it is approved, is transferred to your bank account. Now, if you realise that the expenditure you had borrowed the amount for has been delayed, you still have to pay interest on the loan amount since it has been already transferred to you. You can avail an amount from your approved line of credit anytime after it is approved and interest needs to be paid only on the amount availed and from the time it is availed on.

 

Faster availing:

As the application and availing are the same in a personal loan, you have to wait till the loan is approved to avail your amount. Whereas in a line of credit, application and approval is done beforehand and availing within this approved limit is usually instantaneous.

 

Less ambiguity:

When you apply for a personal loan for a certain amount, the financial institution then processes your application and could reject or approve it for a lower amount. In a line of credit application, typically there is no need to specify an amount. The financial institution automatically approves your application for the maximum amount possible, from which you can avail what you need. This might help in planning your finances better and you don’t have to guess what’s the exact amount you’ll need before applying.

 

Choosing the optimal tenure:

In a personal loan, you pick a tenure for the whole amount and stick to it till you pay it off. In a line of credit, this doesn’t have to be the case as financial institutions usually allow you to pick your tenure each time you avail an amount. For example, assume you avail 50% of your credit limit and decide to take it at a tenure of 9 months. A few days later you decide to avail the remaining 50% but in the meantime, you have also got a pay hike and feel you can pay higher EMIs, you can choose the tenure for the remaining 50% as 3 months or 6 months.


 

We hope that understanding these key differences between a personal loan and line of credit will help you make more informed financial decisions in the future. If you want to avail a line credit, then NIRA is always there for you. Our process is simple and instant, giving you the financial freedom to plan your life better. Download the NIRA app to apply for a line of credit with us.

 

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