How Is a Personal Loan Different From Credit?

When you need to borrow money you have a number of choices to make: bank or credit union? Credit card or home equity loan? Fixed or variable rate? One option you may be considering is a personal loan. If so, what makes these loans different?

Here are four differences between a personal loan and credit:

1.
They carry fixed interest rates.

That makes them different than, say, a home equity line of credit which usually carries a variable interest rate that can change when interest rates in the economy change. Variable-rate loans my look more attractive at first since their "initial" rates are often low. But the rate (and payment) may rise later, and may make the loan more expensive (and risky) over time.

[Related article: How to Shop for a Personal Loan]

2.
You must pay them back in a certain amount of time.

Most personal loans carry a fixed repayment period of one to five years. During that time you make fixed monthly payments. That makes them different than credit cards, which allow you to make a minimum payment that will barely make a dent in your balance. If you prefer the certainty of knowing when your debt will be paid off, a personal loan may be your preferred choice.

3.
They give entrepreneurs a chance to prove themselves.

It's become more difficult over the past few years to borrow to start or jumpstart a young or small business. Brand-new businesses, for example, aren't likely to find a bank that wants to give them a loan just because they have a great idea for a business. Banks often want to see sales and revenue figures, which newer businesses aren't likely to have. That's why some small businesses are turning to personal loans, which they obtain on the strength of their personal credit and finances, rather than that of the business. And the interest paid on a personal loan used strictly for business purposes is often tax deductible; talk with your tax adviser. If you want to see a snapshot of your credit situation and see if you'd likely qualify for a personal loan, use the Credit Report Card.

[Related article: The Ultimate Credit Report Cheat Sheet]

4.
They're the new home improvement loan.

A few years ago, if you wanted to build a deck or remodel your kitchen, your bank or credit union was probably more than happy to give you a home equity loan to fund your project. But now, between stricter mortgage loan requirements and home values down in many parts of the country, getting a home equity loan may feel like more trouble than it's worth. That's why many borrowers are turning to these loans to fund home improvement projects. And unlike home equity loans, which often require interest-only payments for ten years before the borrower has to start repaying the principal, with a personal loan you'll know your project is paid for in a few years -- before you're ready to start a new one!

[Related article: What Is My APR, Really?]

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