These are the two primary credit options available to the consumer for borrowing small to medium amounts of money. So which option is right for you?
The Line of Credit can be either secured by the equity in your home or by investments you hold such as an RRSP. In either case, the borrower is assigning that security to the bank as a guarantee in the case of default.
The line of credit can operate either as a separate account or as an extension to your chequing account. This type of borrowing is usually the least expensive in that the interest rates are at or around the bank prime rate. This means that in most cases it is a variable rate loan. It is in essence a revolving charge account. As it is paid down, that credit once again becomes available. Sound too good to be true? Maybe or maybe not. It still requires the borrower to make payments to reduce the principle on a regular basis. Certainly an interest only payment can be made, but principle reduction is the goal, the same as if it was a regular loan.
It has the flexibility of allowing the borrower to access funds instantly, within the limits of the account. However it should be noted that in order to keep your credit rating in good order, you should not allow it to come close to 90% of that limit. Need a new car? If the credit is available it is as simple as writing a cheque. Home improvements? Same thing, write the cheque.
So why are the banks promoting the Line of Credit? Simply it provides for secured loans without the paperwork and approval processes, so they are counting on the consumer using it. They are also counting on it being in constant use year after year so the interest payments are continual. If you have a good credit rating and good security they are more than willing, in fact, encouraging you to take out this type of loan. Your good credit history benefits both you and the bank.
The Personal Loan is the traditional credit vehicle for those big ticket items. It can be either a fixed rate or variable rate loan and is for a specified amount with repayment over a specified time. Additionally it can be either open or closed meaning if open you can pay it off at any time without penalty, or closed where it must run for the contracted time of the loan. No matter what option you choose, you will pay a higher interest rate for this credit, but you have definite limits in all areas. You borrow only what you need and you repay it according to the terms of the borrowing agreement. This type of loan can be independent of a guarantor (co-signer) or it could require one. The bank could also ask for additional security pledges against the loan and often do.
In other words let’s assume you are going to borrow $20000 for a new car that is worth $22000. The devaluation of the vehicle could easily exceed the loan reduction. In such a case the bank will ask for additional security or guarantees so that in the case of default, they aren’t stuck with a balance owing or $15,000 and a vehicle worth only $12000.
In either case of Personal Loan or Line of Credit, you can be sure the lender will have more security than the value of the loan, and the more they can get the easier it is to get the loan. Both methods of borrowing have their advantages and disadvantages and it is up to the consumer to decide which is best for the circumstances.
The last thing the bank will ask for is insurance coverage on the loan in case of death or disability of the borrower. Read the fine print carefully or have a solicitor review this. Recent problems in this industry have rendered loan insurance in that category of being questionable when it comes to making use of it.