@chriscastgarcia/Twenty20
Personal loans and personal lines of credit are two ways to borrow money that typically don’t require collateral. However, they’re functionally different. A personal loan gives you a lump sum of money upfront and requires fixed monthly payments throughout your loan term. On the other hand, a personal line of credit lets you withdraw as much cash as you need at any point in time and pay it back on your own timeline with a variable interest rate.
Both personal loans and personal lines of credit can be a good way to borrow money; the best one for you depends on your financial habits.
Personal loans vs. personal line of credits
From a broad perspective, a personal loan and a personal line of credit ultimately serve a similar purpose. A lender lets you borrow funds based on an agreement, and you can use those funds as you see fit. The biggest difference between a personal loan and a personal line of credit is the terms of each type of loan.
Personal loans
Personal loans are a type of loan that gives you a fixed amount of funding distributed in a lump sum. They are generally used for one-time expenditures. Your payments with a personal loan will be the same each month because they have fixed interest rates and a fixed repayment timeline. You can get a personal loan from a local bank, credit union or online lender.
Personal loans are normally used for:
- Paying down credit card debt.
- Financing a large purchase.
- Paying for a wedding.
- Paying off student loans.
Takeaway: Personal loans are ideal when you’re planning a large one-off purchase and would like to have predictable monthly payments.
| Pros | Cons |
|---|---|
| Funding in one lump sum | Higher interest rates |
| Consistent payment amount | Loan fees and penalties |
| Fixed interest | Monthly payments are higher than credit cards |
| Fixed repayment timeline | Stricter eligibility requirements |
| No collateral requirement | Fixed repayment timeline |
Personal lines of credit
A personal line of credit, like a credit card, is an unsecured revolving credit line with a credit line limit and a variable interest rate. A personal line of credit could be an ideal solution if you’re trying to manage purchases and aren’t clear on the overall scope of the costs. While your payments on a personal line of credit will change due to variable interest rates, you’ll pay interest only on the portion of the credit line that you use. Personal lines of credit may be available from your community bank or through a variety of online lenders.
Personal lines of credit are normally used for:
- Home improvement projects.
- Overdraft protection.
- Emergency situations.
- Supplementing irregular incomes.
Takeaway: If you’re unsure of how much you need to borrow or how often, a personal line of credit can be a flexible lending option.
| Pros | Cons |
|---|---|
| Pay for only what you use | Variable interest rate |
| Lower interest rates than credit cards | Fluctuating repayment amount |
| Ongoing access to funds | Potential to overspend |
| Funds can be used for nearly any purpose | Strict eligibility requirements |
Types of credit lines
There are three types of credit lines– personal, business and HELOC.
Personal
As the name suggests, a personal line of credit is used to cover personal expenses. Beyond the reasons mentioned above, it can also help make your cash flow more manageable if your income is irregular.
Business
If you own a small business and need access to working capital, a business line of credit is a flexible solution worth considering. You can use it however you see fit to cover business-related expenses, and both approval and funding times are often shorter compared to traditional business loans. Also, know that business lines of credit can be both secured and unsecured.
HELOC
A HELOC or home equity line of credit allows you to pull cash from the equity in your home. It’s secured and acts as a second mortgage, so you could lose your home to foreclosure if you default on the loan payments. The upside is if you can comfortably afford the loan payments, you could get a competitive interest rate than you would with a personal loan. Some lenders also offer fixed-rate options to give you more predictable borrowing costs and monthly payments.
Biggest similarities between personal loans and personal lines of credit
Although a personal loan and a personal line of credit are different, they share several similarities:
- Hard credit check: Applying for either one of these types of borrowing will cause a hard credit check for approval — meaning your credit score will be affected.
- Interest payments: Both personal loans and personal lines of credit require paying interest on the money borrowed.
- Qualification requirements: The baseline requirements for both a personal loan and a personal line of credit are typically the same.
- Unsecured borrowing: Most personal loans and lines of credit are unsecured, meaning you don’t need to use an asset like your home or car as collateral. This makes them a slightly less risky option than something like a home equity loan.
Biggest differences between personal loans and personal lines of credit
Personal loans and personal lines of credit also have several differences:
- Funds distribution: The way you receive and repay funds is perhaps the biggest difference. A personal line of credit acts more like a credit card, with a “revolving” credit line and accumulated interest on any unpaid balance. You can take out the money as needed, but you will need to make minimum monthly payments as you would with a credit card. On the other hand, a personal loan gives you the full amount of the loan upfront. You’ll then pay off the loan in monthly installments over a set repayment period.
- Higher interest rates: Personal lines of credit usually have higher interest rates because they involve greater risk on the part of the lender.
- Variable interest: Interest rates with a personal line of credit are variable — unlike those of personal loans, which are determined during the application process and remain fixed for the life of the loan.
How to determine which option is best for you
Before you choose between a personal loan and a personal line of credit, determine your level of need. Each loan product has its particular benefits, and you’ll want to pick the one that best suits your circ*mstances.
A personal line of credit could be an ideal solution if you aren’t sure exactly how much money you’ll need to borrow. It’s best suited for ongoing expenses like an unpredictable home repair project. As with a credit card, you pay interest only on the portion of your credit limit that you actually use. Remember, personal lines of credit charge variable interest rates. This means that your monthly payment that’s due will vary, as will the total interest charges you might accrue.
On the other hand, personal loans offer fixed interest rates that don’t change for the duration of the loan. This means that you can expect the same payment amount due for each installment, making managing your finances easier. Personal loan funds are also distributed in one lump sum, so they are generally best for large, one-time expenses, like paying down credit card debt, financing a large purchase, paying for a wedding or paying off student loans.
The bottom line
Personal loans and a personal line of credit serve a similar purpose (allowing you to borrow cash), but they function differently. A personal loan provides you with a single lump sum of money with a fixed monthly payment while a line of credit provides ongoing access to funds. To decide which type of borrowing is right for you, carefully consider how you plan to use the money and your financial habits when it comes to responsibly managing and repaying debt.
Whether you choose a personal loan or a personal line of credit, it’s important to know where your credit score stands to get a sense of which loans you could be eligible for. You can request a free credit report through AnnualCreditReport.com to review your credit history before submitting an application with a lender. Then compare quotes from a few different lenders to see which will give you the best deal.
