Personal Loan vs. Personal Line of Credit

Borrowing money to cover a large expense or manage debt often involves choosing between a personal loan vs personal line of credit. These two popular financing options fall under unsecured borrowing, meaning no collateral is required.

Both options offer flexible access to funds and usually come with competitive interest rates. However, they differ in how funds are disbursed and repaid.

Deciding between a Personal Loan vs. Personal Line of Credit depends on the amount needed, repayment preferences, and financial goals. Understanding how each option works can help you make a confident and cost-effective borrowing decision.

A personal loan is a type of installment credit that provides a lump sum of money upfront, which is then repaid through fixed monthly payments over a set period. It’s a versatile borrowing option suited for everything from debt consolidation to major life expenses. Here’s how it typically works:

Annual percentage rate (APR): Most personal loans come with a fixed APR, which combines the interest rate and any associated fees into one yearly cost. With a fixed rate, monthly payments stay the same for the entire loan term. For borrowers with strong credit, personal loan rates are often lower than those for personal lines of credit.

Loan amounts: How much you can borrow depends on factors like your income, credit score, and the lender’s criteria. Personal loan amounts can range widely, from $1,000 up to $200,000 with some lenders.

Repayment terms: Loan terms usually span from one to seven years. Shorter terms mean higher monthly payments but less interest paid overall. Thanks to the fixed structure, your payments remain consistent from start to finish.

Funding: Unlike a personal line of credit, which allows you to draw funds as needed, a personal loan delivers the entire approved amount in one disbursement. Depending on the lender, the funds could be deposited on the same day or within a few business days.

Secured vs. unsecured: Personal loans are generally unsecured, meaning no collateral is needed. However, some lenders may offer secured personal loans, which require assets such as a vehicle or savings account to back the loan.

A personal line of credit gives you flexible access to funds, letting you borrow as needed up to a set credit limit. Instead of receiving one large payment, you can draw from your available balance over time, making it a practical option for ongoing or unpredictable expenses. Here’s what you need to know:

Revolving credit: This borrowing method functions much like a credit card. You can access funds multiple times, repay what you’ve used, and borrow again as long as you stay within your approved limit.

Interest rates: Most personal lines of credit come with variable rates that fluctuate based on market conditions. While rates are typically higher than personal loan rates, they’re usually lower than what you’d pay with a credit card.

Credit limits: Your approved limit depends on factors such as creditworthiness and income. Lenders often offer lines of credit ranging from a few thousand dollars up to $50,000 or more.

Draw period: Instead of receiving a lump sum, you can withdraw funds as needed during an initial draw period. You’re free to borrow in smaller amounts at different times, up to your available credit.

Repayment period: Once the draw window closes, you’ll begin repaying the balance. Unlike fixed-term loans, repayment is often more flexible. Minimum payments may cover just interest or a percentage of your outstanding balance.

Funding: You won’t receive the full credit limit upfront. Instead, funds are available on demand within your limit. Some lenders may charge a fee each time you access your line of credit, so it’s important to understand the terms.

Both personal loans and personal lines of credit are flexible borrowing options that can be used for a wide range of financial needs. They’re usually unsecured, meaning no collateral is required, and available through banks, credit unions, and online lenders.

While they share some similarities, there are important distinctions in how funds are accessed, repaid, and used. The right choice depends on your financial goals and how you prefer to manage repayment.

Key Differences Between a Personal Loan and a Personal Line of Credit

Before deciding on a personal loan, it’s important to understand both its advantages and potential drawbacks. Here’s a quick overview to help you weigh your options.

• Higher Borrowing Limits: Personal loans typically offer larger amounts compared to personal lines of credit. Depending on your creditworthiness and the lender, you may be able to borrow $100,000 or more.
• Attractive Interest Rates: If you have a good credit score, personal loans often come with competitive rates that can be lower than those on personal lines of credit.
• Predictable Payments: With fixed interest rates, personal loans come with steady monthly payments. This means you won’t have to worry about your rate increasing over time.

• Single Lump-Sum Borrowing: Unlike a personal line of credit, you get one lump sum with a personal loan. If you need additional funds later, you’ll have to apply for a new loan.
• Possible Fees: Some lenders charge fees such as origination fees, application fees, or penalties for paying off your loan early.
• Higher Monthly Payments: Since the loan must be paid off within a set timeframe, your monthly payments may be higher compared to a personal line of credit, which offers more flexible repayment.

Considering a personal line of credit? It’s helpful to know both the benefits and limitations before deciding if it’s right for you.

• Flexible Access to Funds: A personal line of credit lets you borrow repeatedly up to your credit limit unlike a personal loan. You can draw money whenever you need it and pay it back on your schedule.
• Only Pay Interest on What You Use: Interest is charged only on the amount you actually borrow, not the total credit limit. This can save you money compared to loans where interest starts accruing on the full amount upfront.
• Great for Ongoing Expenses: A personal line of credit gives you the continuous financial flexibility you require if you have recurrent or unforeseen obligations, such as home repairs, medical bills, or educational charges. 
• Variable Interest Rates: As rates may fluctuate, this often means you could benefit from lower interest costs if market rates drop.

• Variable Rates Can Increase: Since interest rates are usually variable, your payments might rise if rates go up, making budgeting more challenging.
• Possible Fees to Consider: Some lenders charge fees like annual fees, draw fees, or overdraft fees, which can add to your overall costs.
• Temptation to Overspend: Having ongoing access to credit can make it easy to borrow more than you need, which might lead to debt accumulation if you’re not careful.
• No Fixed Repayment Schedule: Without set monthly payments, it can be harder to plan your finances or pay off the balance quickly.

Knowing the procedures and requirements that lenders look for is helpful if you’re considering applying for a personal loan. This simple advice will help you get ready and increase your chances of getting accepted.

Check Your Eligibility

Before you apply, make sure your financial situation aligns with typical lender requirements:

• Credit Score: Many lenders prefer borrowers with good to excellent credit. While some offer loans to those with lower scores, keep in mind that interest rates may be higher in those cases.
• Proof of Income: You’ll need to provide evidence of steady income, such as pay stubs, tax returns, or bank statements, to show you can repay the loan.
• Debt-to-Income Ratio: Lenders often look for a debt-to-income ratio (DTI) below 35%, meaning your monthly debts shouldn’t exceed 35% of your monthly income. The lower your DTI, the stronger your application.

Compare Lenders

Don’t rush your choice. Shop around to find lenders like SoFi, LightStream, Upgrade, Discover, and LendingPoint based on your credit profile, desired loan amount, and the interest rates and fees they offer. This can help you get the best deal possible.

Prequalification

Many lenders offer a prequalification process that won’t affect your credit score. This lets you see your potential interest rates and loan terms before formally applying. While prequalification doesn’t guarantee approval, it’s a useful way to narrow down your options.

Complete the Loan Application

Once you pick a lender, you’ll fill out an application, usually online. You’ll need to share personal details, financial information, and consent to a hard credit check, which may cause a temporary dip in your credit score.

Receive Your Funds

After approval, the timing for receiving your loan varies. Some lenders can deposit the money within a day, while others may take up to a week or more. Make sure to ask about funding timelines before you commit.

A personal loan is a great option when you need a specific amount of money for a one-time expense and have a clear understanding of how much you need to borrow.

For instance, many people turn to personal loans to consolidate debt. They calculate their total debt and take out a loan to pay off multiple creditors all at once, simplifying their finances.

Personal loans are also commonly used for significant purchases or unexpected emergencies. Say your car suddenly needs a $2,500 repair, but you don’t have the cash on hand. A personal loan can cover that exact amount, helping you manage the cost without stress.

The lender will do a rigorous credit investigation when you apply for a personal loan or personal line of credit. Your credit score may temporarily decline as a result of this, often by a few points.

However, your payment history plays a much bigger role in your credit health. Making payments on time consistently will help boost your score, while late payments, especially those over 30 days, can be reported to credit bureaus and lower your score.

Personal loans and personal lines of credit influence your credit score differently, particularly when it comes to your credit utilization ratio. Since a personal line of credit is a revolving form of credit, any outstanding balance increases your credit utilization. This ratio is the second most important factor in calculating your credit score, and experts typically advise keeping it under 30%.

On the other hand, personal loans are installment loans and don’t impact your credit utilization. That’s why using a personal loan to pay off credit card debt often leads to an improvement in your credit score, as it reduces your revolving credit balances.

Personal loans and lines of credit are helpful financial options, but they aren’t always the best fit for every situation. Here are some common alternatives to consider that might better suit your needs.

Credit Cards

Credit cards provide flexibility similar to a personal line of credit and often come with perks like cash back or travel rewards. Although interest rates on credit cards tend to be higher than those on personal loans or lines of credit, you can avoid interest charges altogether by paying off your balance in full each month.

Home Equity Loans

Because a home equity loan is backed by your property, it may be possible to access the equity in your house and receive cheaper interest rates if you are a homeowner. However, keep in mind that this kind of loan works similarly to a second mortgage, so defaulting might jeopardize your house.

Home Equity Lines of Credit (HELOCs)

A HELOC combines aspects of a home equity loan and a personal line of credit. It uses your home as collateral, but you can borrow what you need when you need it and only pay interest on the amount you draw, giving you ongoing access to funds at a potentially lower rate.

Related: HELOC vs Personal Loan

Cash Advances

Cash advances let you borrow a small amount quickly, but they usually come with higher fees and interest rates than regular credit card purchases. They might be useful in emergencies, but it’s wise to explore other options first to avoid extra costs.

Buy Now, Pay Later (BNPL)

BNPL services let you split purchases into interest-free installments, offering flexible financing at the point of sale. While convenient, these services can sometimes encourage overspending, so it’s important to use them responsibly.

Differences between personal loans and personal lines of credit can significantly impact your financial decisions. Personal loans offer a fixed amount and predictable payments, making them suitable for one-time large expenses or debt consolidation. Personal lines of credit provide flexible access to funds as needed, which is useful for ongoing or unexpected costs. Taking into account interest rates, repayment schedules, fees, and credit implications will help match the right option to your unique financial needs and goals. This ensures smarter borrowing and better control over your financial future.