From its pros and cons to the details of how it can affect your score, you will find in this guide everything you need to know about personal loans. Take a look!
Do you know what's the difference between a loan and a line of credit? Are you aware of how a personal loan can affect your score? Then, you need to take a look at this guide and learn everything you need to know about personal loans.
The difference between a loan and a line of credit
Do you know what's the difference between these two ways of borrowing money? Do you know their pros and cons? Although a loan and a line of credit may sound quite the same, they are different forms of borrowing and each one has its pros and cons.
So, before you take out either of these options, make sure that you understand the main differences between them.
The way the money is dispersed it's one of the main difference between these two borrowing systems.
In the case of loans, you will receive a lump-sum payment, all at once, and will then regularly pay back that amount with interest over a period of years. This is how mortgages, student loans, auto loans and personal loans work.
Once you borrow the money, you will have fixed monthly payments until you've repaid the entire loan.
On the other hand, a line of credit works more like a credit card. You don't need to borrow up to the maximum, you can borrow exactly what you need and pay back only what you've borrowed.
A great example of a line of credit it the HELOC (Home Equity Line of Credit), in which a lender approves credit for a determined amount of money based on the equity you've built up in your home. You will then start paying it back in monthly installments, also with interest.
Regarding monthly payment, in this case, it will vary depending on the total amount you've borrowed.
- Interest rates and closing costs
Interest rates are usually lower in loans than in lines of credit. However, closing costs are higher with loans. This means that there are higher fees and charges in a loan.
Pros & Cons
Personal loans offer a set amount of money at a fixed interest rate and a fixed monthly payment. That’s why they are considered a predictable option when it comes to borrowing money. But let’s dig a bit deeper and see what are the advantages and disadvantages of personal loans.
What’s cool about personal loans?
If you have good credit, you can pay a fixed interest rate that is usually much lower than the ones offered by other products.
You have the exact same monthly payment, month after month, so you know exactly how much you need and when it will be paid off.
As a personal loan offers a set amount of money as opposed to a line of credit, there is no way you could be tempted to overspend and purchase things you then struggle to pay off.
What’s not so cool about personal loans?
- In order to get a loan with the best interest rates, you need to have an excellent credit score —or individuals with a FICO score of 740 or higher.
- As you have to make a fixed payment each month, you can’t make smaller payments if you ever need to. You will have to come up with the exact amount to pay each monthly balance in full.
- Some personal loans have fees, such as an origination fee or insurance.
Personal loans are a good option for those who need to borrow for a specific goal such as a home remodel or repair, as it allows borrowers to come up with a repayment plan thanks to the fixed payments they offer.
Before requesting a personal loan, compare lenders and what they offer to choose the one that suits you best!
How can it affect your credit score?
As most personal loans are unsecured, lenders use your credit score to determine if you get approved or not. During the life of the loan, your score might fluctuate in different stages.
What are those stages?
When you apply for the loan
Before actually getting a personal loan, you need to apply in order to get approval. Lenders will base their decision on your credit score, so the higher it is, the better conditions you might get.
They do this by performing a hard-check, which means you give permission to a certain company (usually, the potential lender) to check your credit history. Every time a lender triggers a hard inquiry, your credit score will temporarily decrease.
When you get your loan
Once you get your personal loan, you increase your credit mix, which is basically 10% of your total score. So at this stage, your score might get a little boost. But as you are also increasing the amount of debt you owe, a personal loan could also cause it to drop.
An important thing to keep in mind when choosing a lender is that they report your repayment history to the three major credit bureaus. Lenders are not required to report your payment history, and if they don’t, then you won’t be able to show that you worked hard and never missed a payment.
When you repay your loan
Before taking a loan, you need to make sure you can pay for it. Depending on your credit score, your loan conditions might be different. If you have a low credit score, you might have to pay higher interest rates, so make sure you include that in your budget.
Keep in mind that your credit score has different factors, but the most important one (around 35%) is your payment history. If you miss one single payment, your score can drop dramatically.