Personal loan vs. personal line of credit: What’s the difference?
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 sum of money upfront and requires fixed monthly payments throughout your loan term. A personal line of credit, on the other hand, 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 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.
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. If you’re trying to manage purchases and aren’t clear on the overall scope of the costs, a personal line of credit could be an ideal solution. 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.
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:
- Both require interest payments
- Applying will cause a hard credit check for approval — meaning your credit score will be affected.
- The baseline requirements for both a personal loan and personal line of credit are typically the same.
- 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 key differences:
- Personal lines of credit usually have higher interest rates, because they involve greater risk on the part of the lender.
- 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.
- 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.
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 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. 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
Whether you’ve chosen 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.