What is a personal line of credit? When you’re trying to manage your expenses, it’s important to know the answer to that question. Some people think personal loans and personal lines of credit are the same, but they’re not.
So, what’s the difference and which is the better option for fixing your finances? Let’s explore each of these tools in greater detail.
Personal loans consist of a fixed amount of funding distributed in a lump sum. They are generally used for one-time expenditures. In the case of unsecured personal loans, there is no collateral required.
Once you are approved and sign for the loan, the lender deposits the loan amount into your bank account or otherwise gives you the entire principal of the loan. Repaying a personal loan usually takes place over a fixed period of time at a fixed interest rate.
Personal loans are normally used for…
- Paying down credit card debt.
- Financing a large purchase.
- Paying for a wedding.
- Paying off student loans.
Personal lines of credit
If you are trying to manage a purchase and you aren’t quite clear on the overall scope of the costs, then a personal line of credit could be an ideal solution. How does a line of credit work? A line of credit, like a credit card, is an unsecured revolving credit line, with a credit-line limit and usually a variable interest rate.
It is suited for ongoing expenses, such as a home repair project. You pay interest only on the portion of the personal line of credit that you use.
Personal lines of credit are normally used for…
- Home improvement projects.
- Overdraft protection.
- Emergency situations.
- Supplementing irregular incomes.
Personal loans vs. personal lines of credit
If you’re thinking about borrowing money from a lending company, it’s important to know your options with a personal line of credit versus a personal loan. These terms are easily confused, so let’s take a close look at each.
Personal line of credit vs. loan: What’s similar?
The first thing to keep in mind before taking out a personal loan or line of credit is that both require interest payments, as well as a hard credit check for approval — meaning your credit score will be affected. And while the specific qualifications will differ based on the product, baseline requirements are typically the same. These may include:
- Low debt-to-income ratio.
- Good credit score.
- Stable income.
Personal line of credit vs. loan: What’s different?
Personal loans and lines of credit differ in a few key ways. For one, personal lines of credit usually have higher interest rates, because they involve greater risk on the part of the lender. Interest rates are also variable — unlike those of personal loans, which are determined during the application process and remain fixed for the life of the loan.
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 money as needed, but you will need to make minimum monthly payments as you would with a credit card.
A personal loan, on the other hand, gives you the full amount of the loan upfront. You’ll then pay off the loan in monthly installments over a set repayment period.
Personal Line of Credit
$1,000 – $50,000 on average
$1,000 – $100,000 on average
|Interest rate: fixed or variable||
Fixed; variable is uncommon
Variable; will rise and fall depending on the market
10% – 28%
12 – 60 months
10 years on average
|Minimum monthly payment
Never changes after the loan closes
Will fluctuate depending on interest rate movements; may come with a low promotional rate initially
1% – 8% on average
Can be charged monthly once the line is opened
How to choose a personal loan vs. line of credit
Before you choose between a personal loan and a personal line of credit, be sure to determine your level of need. Each loan product has its particular benefits, and you’ll want to pick the one that best suits your circumstances.
If you aren’t sure exactly how much money you’ll need to borrow, a personal line of credit could be an ideal solution. It’s best-suited for ongoing expenses, such as an unpredictable home repair project. Like a credit card, you pay interest only on the portion of your credit limit that you actually use.
On the other hand, because personal loans distribute funding in one lump sum, 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. For unsecured personal loans, no collateral is required.
If you’re thinking of getting a personal loan, check out Bankrate’s personal loans rate table to quickly compare your options.