Prospective borrowers with excellent credit may have the luxury of choosing between an unsecured personal loan and an unsecured line of credit. These types of loans work differently, and the right one for you depends on your specific needs.
Application Process and Attainability
The application process for both unsecured loans and unsecured lines of credit can be rigorous. Because banks have no collateral to seize if you do not pay, the lender's approval for either type of credit depends significantly on your capacity to repay, any capital or collateral you have available to you, your past payment history and even your character. Because you must have a strong credit rating to qualify for unsecured credit of any kind, you likely will qualify for an unsecured line of credit line if you also qualify for an unsecured loan, according to a 2014 report in Fox Business.
If the lender declines to issue an unsecured loan or line of credit, you may still be able to qualify for a secured loan or line of credit. These types of loans represent lower risk to the bank.
How They Function
When you take out an unsecured personal loan, the lender will provide you a one-time payment of the entire amount you borrow. During the lending process, the bank will tell you exactly how many payments you will make to repay the loan, the amount of each payment, and the total amount you will pay back over time.
With a line of credit, the lender will approve you for a certain amount. It will not issue those funds right away. Instead, it will give you checks or another payment instrument you can use to draw from the line of credit. With a line of credit, either secured or unsecured, you can borrow up to the approved amount at any time. As you repay the loan and your balance drops below your credit limit, you can borrow more if necessary. Unlike a loan, which banks issue once and you repay over time, a line of credit may be subject to changes in interest rates, credit limits or availability if your financial situation should change.
Many people take out an unsecured personal loan to finance a major one-time purchase. In such cases, the regular, fixed payments and predefined term can make a personal loan an attractive option. In contrast, you may find a line of credit useful if you will incur expenses over time, as you would if you were building an addition to your home, attending college, starting a business or remodeling your home room by room.
The lender will set the interest rate for your unsecured personal loan at the time it approves and funds the loan. The bank will use an array of factors to determine your interest rate, but personal loans typically have a fixed interest rate for the duration of the loan. The interest rate on an unsecured line of credit, according to Debt.org, is based on when you access the credit, so your rate may adjust based on when and how much you borrow.
You will almost certainly get a lower interest rate with a secured loan or a secured line of credit, according to Forbes.