Personal Loan vs. Line of Credit: What’s the Difference?

When you need to borrow money to consolidate debt, pay for home improvements or cover an emergency expense you may look to personal loans or a line of credit as the answer.

While either one can help you get cash when you need it, they aren’t exactly the same thing. If you’re on the fence about whether to take out a personal loan vs. line of credit when you’re in search of financing, here’s a closer look at how the two compare.

Personal Loans Explained

A personal loan is a set amount of money you borrow from a bank, credit union or online lender and pay back over time, with interest. When you get a personal loan, you’re getting a lump sum of cash that you can use for just about any purpose as long as it’s approved by the lender.

Personal loans can charge an annual percentage rate, which represents the cost of having the loan annually, based on the interest rate and fees. For example, some lenders may charge an origination fee upfront to get a loan or a prepayment penalty if you decide to pay your loan off early.

Aside from the APR and fees, personal loans can vary greatly in terms of how much you can borrow, how long loan repayment lasts and the minimum requirements needed for approval. Comparing loan rates and terms from multiple lenders can help you find the one that’s the right fit.

When to Choose a Personal Loan

Personal loans can fit a number of financial needs, including:

• Consolidating high interest credit card debt
• Paying for home renovations or repairs
• Covering medical bills
• Paying for moving expenses
• Planning a wedding
• Funding a vacation

Depending on the lender you may even be able to use a personal loan to start a business, pay off tax debts or cover college tuition.

Using a personal loan vs. a line of credit could make sense if:

• You have a set dollar amount you need to borrow
• You’re interested in securing a personal loan at a low fixed APR
• You want predictable monthly payments that you can work into your budget

Personal loans don’t necessarily require perfect credit to qualify, which could be helpful if you’re hoping to use one to build credit. Just keep in mind that the better your credit score is, the better your loan terms are likely to be.

Line of Credit Explained

A line of credit is similar to a credit card, in that you have access to a revolving line of credit you can borrow against. Instead of getting one lump sum of money the way you would with a personal loan, you can draw against your available credit line as needed.

You’d then make payments toward your balance each month, freeing up more available credit in the process. Lines of credit can come with fixed interest rates, though it’s also common for lenders and banks to charge variable interest rates instead. Variable rates are tied to a benchmark rate; when the benchmark rate rises or falls, the rate on your loan can follow suit.

Lines of credit can be useful for things like:

• Paying for everyday living expenses if you can’t work because of illness or a layoff
• Making a large one-time purchase
• Covering ongoing expenses related to medical care
• Paying for ongoing home repairs or improvement projects
• Covering business expenses when sales are slow

Between a personal loan and a line of credit, a line of credit could come with higher borrowing limits. But they can be more difficult to qualify for compared to personal loans.

You may want to choose a line of credit over a personal loan if:

• You aren’t sure exactly how much money you’ll need
• You’re comfortable paying a variable interest rate that may change over time
• You have good to excellent credit to help you qualify for the best rates

One thing to pay attention to are the repayment terms. Instead of fixed monthly payment you’ll typically have a minimum balance you need to pay for a line of credit. But similar to a credit card, only paying the minimum could make it harder to make a dent in the balance. Additionally, your lender may charge a monthly fee to keep your credit line open, something you don’t usually encounter with a personal loan.

Bottom Line

Both personal loans and lines of credit can help you fill short- or long-term gaps in your financial plans. Regardless of which one you choose, take time to compare borrowing options from different lenders. Check the loan or line of credit’s terms, rates and fees to see which one is the best option for your budget. Also, consider the minimum credit score and income requirements different lenders expect you to have. By doing your homework beforehand, you can avoid any unpleasant surprises during the borrowing process and after you’re approved.