Personal Line Of Credit Vs. Personal Loan: Explained
A personal line of credit and a personal loan are both options for borrowing money directly from a bank or another financial institution. Though similar, a line of credit and a personal loan have differences in key areas such as their interest rates and qualification requirements.
Most people will need to borrow money at some point to pay for a life event like a wedding or to fund a home improvement project. Learning more about these two ways of borrowing money can help you decide if a personal loan or a personal line of credit is a good option for you.
Let’s take a close-up look at a personal line of credit versus a personal loan, explore the differences and similarities, and consider the pros and cons of each.
What Are Personal Lines Of Credit And Personal Loans?
To get an idea of how these two types of financing differ, let’s start by defining these two terms.
Personal Line Of Credit
A personal line of credit is a type of revolving credit, similar to a credit card, that you can borrow from when you need up to a certain dollar amount or credit limit. Personal lines of credit are usually considered unsecured, which means you don’t need to provide collateral to get one. Instead, lenders base their approval primarily on your credit score and income. A personal line of credit may have a draw period when you borrow money, followed by a repayment period when you can no longer borrow and must begin repayment.
If you want a personal line of credit, you’ll likely need good or excellent credit. Personal lines of credit tend to be best suited for situations when the amount of financing you’ll need is variable and may unexpectedly change, as in the case of a long renovation project or ongoing medical expenses.
Personal Loan
A personal loan is an installment loan that you can use for almost any type of expense. Like a personal line of credit, a personal loan is most often an unsecured loan, but the way a personal loan works is different from a personal line of credit. With a personal loan, you’ll take out a fixed amount of money in a lump sum and repay on a specific schedule.
Personal loans can be used for various reasons but are often best for large one-time expenses like home repairs, big life events or debt consolidation. You may qualify for a personal loan with just an average credit score, but the tradeoff is a likely higher interest rate. The better your credit score, the more likely you are to qualify for a lower interest rate.
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Differences Between A Line Of Credit And A Personal Loan
Although a personal line of credit and a personal loan serve a similar purpose, they differ on several levels. Here are some of their key differences:
Personal line of credit | Personal loan | |
|---|---|---|
Minimum credit score | Often 670 but varies by lender | Often 580 but varies by lender |
Distribution of funds | Revolving line as needed | Lump sum |
Credit type | Revolving | Installment |
Type of interest | Variable rate | Fixed rate |
Interest rate | Often around 10% APR but varies by lender | 4% – 36% APR |
Term length | Ongoing, but repayment terms vary by lender | Typically 2 – 7 years |
Fees | May include overdraft fees, late fees and/or annual fees | May include application fees, origination fees, late fees and/or prepayment penalties |
Distribution Of Funds
One big difference between a line of credit and a personal loan is the way you’ll receive the money once you’ve been approved. For a personal loan, you can expect to have the funds arrive in a single lump sum once your application is finished and the loan is processed.
A personal line of credit works a bit differently. Once you’ve been approved, you’ll typically access funds with a card or checks connected to your account. You can draw from your funds at any time and in any amount up to your approved credit limit. This way, borrowers can use the money to make purchases as necessary, pay down the balance and borrow again as needed.
Credit Type
A personal loan is a type of installment loan, which means you borrow a specific amount of money that you repay over a fixed period of time. So, you can always expect the same payment each month.
A personal line of credit is considered revolving credit, meaning you can borrow money from the same line of credit multiple times as long as it’s available to you. Since your withdrawals and interest rate may vary, your monthly payments will likely also change.
Type Of Interest
Another key difference is the type of interest you’ll pay on any money you borrow. One of the advantages of a personal loan is that you’ll have a fixed interest rate until you’ve paid the loan completely off. With a fixed-rate loan, you always know how much interest you’ll pay and the total you’ll owe each month. A personal loan can be a great strategy for debt consolidation, because it allows you to pay on multiple credit cards, student loans and other types of debt in one monthly installment.
In contrast, personal lines of credit have a variable interest rate, meaning the amount of interest you pay can fluctuate based on the prime rate. So, even though your interest rate may be lower than with a personal loan, it comes with a degree of uncertainty, especially in an economic downturn. Since this type of borrowing is flexible, the interest rate is variable and will be reflected in the cost of borrowing money at the time you need it.
Similarities Between A Line Of Credit And A Personal Loan
Although these two methods of borrowing money have distinct differences, they also carry a few important similarities. These commonalities include:
- No collateral: You don’t need collateral such as a house or a car to apply for either a personal line of credit or an unsecured personal loan. Your credit score, financial history and confirmation of employment or other income are all you need.
- Higher interest rates: Compared to some other types of loans or credit, interest rates are relatively high for both a line of credit and unsecured personal loans. Since these loans are based on your creditworthiness and aren’t secured by collateral, you can expect higher interest rates than secured loans.
- Monthly payments: Both a personal loan and a line of credit require you to make monthly payments, which can include both principal and interest.
Personal Loan Vs. Line Of Credit: The Pros And Cons
Now that we know the basics, let’s take a look at the pros and cons of a personal line of credit versus a personal loan.
Personal Lines Of Credit
A personal line of credit may seem ideal if you need flexibility in your borrowing. However, it’s important to keep the pros and cons of this borrowing option in mind. Here are some of the potential pros and cons:
Pros | Cons |
|---|---|
Flexible spending for funds when you need them | An interest rate that’s variable and may change with the market |
Repayment that only applies to the funds you withdraw | The possibility of annual or monthly maintenance fees |
A likely lower overall interest rate than a personal loan | More stringent approval requirements than a personal loan |
Personal Loans
Personal loans can be used for almost any purpose, no matter what expenses pop up in your life. A personal loan can be a great option for everything from paying for college to covering emergency expenses.
Now let’s dig into the pros and cons of a personal loan compared to a personal line of credit.
Pros | Cons |
|---|---|
Lump-sum financing | Less flexibility for ongoing expenses |
Predictable monthly installment amounts | The potential to incur fees and other penalties for missed payments |
Less-rigid approval requirements than a personal line of credit | A smaller maximum loan amount than a personal line of credit |
The Bottom Line
Deciding between a personal loan and a personal line of credit boils down to what’s best for your needs and whether you meet the requirements for one or both financing options. If you have great credit and value flexibility in your borrowing, you may want to consider a personal line of credit.
Meanwhile, a personal loan guarantees access to a large lump sum payment upfront for almost any use. Whether you’re funding your future, taking care of a loved one or consolidating your debt, a personal loan can help you take your next big step.
