Personal Loan vs. Line of Credit: All You Need to Know

When you need a loan, there are way too many different options to choose from.  

Personal loans and lines of credit are both great options for borrowing money. They can both be a solid solution to your financial needs if you want to borrow against future income or to pay off existing debt. But how do they differ? What’s the difference between a personal loan and a line of credit? And what are some other key distinctions between these two types of loans? We’ll dive into all that in this article!  

A personal loan is an unsecured loan that allows you to borrow money at a fixed interest rate. The repayment terms can be flexible and you can repay the loan in monthly installments over a period of time (up to five years). There is no need for collateral, but you need good credit to qualify.  

A line of credit is an agreement between you and your bank or lender that allows you access to funds up to a predetermined limit. It’s like having a pre-approved line of credit from which you can withdraw as needed, but there’s often no set limit on how much can actually be withdrawn at any given time — instead, your line of credit will grow and shrink based on how much money leaves it each month (and stays there).  

Now that we cover some of the main differences between a line of credit and a personal loan, let’s take a look into each type individually so you can determine what’s better: a personal loan or line of credit.  

What Is a Personal Loan and How Does It Work?

A personal loan is a loan that you get from a bank or other financial institution, such as a credit union. You can use the money to pay for anything, like home improvement projects, debt consolidation, and more.  

The repayment term for this type of loan is usually shorter than other types because it’s usually used for smaller amounts. The lender will typically charge an origination fee (setup cost) and interest on your balance throughout the life of your loan.  

Personal Loans: Pros and Cons

A personal loan versus a line of credit is a good option if you need a lump sum of cash and have a specific purpose in mind. The advantage of having a specific goal in mind is that it will help keep you motivated when paying off the debt.  

Pros also include:  

• They can cover a variety of expenses, including tuition costs and car repairs.  
• You will get the needed funds fast. 

On the other hand, cons to this loan type include:  

• They come with higher interest rates than many other types of loans, so it’s important to compare rates before you make your decision.   
• You may have to pay back your personal loan sooner than if you took out a line of credit.   

When to Use Personal Loans?

If you need money quickly and don’t have a lot of time to wait for approval on another loan type, personal loans can be a good option. You may also want to consider them if you need to pay off debt at a lower interest rate than your credit card offers, or if you have a fixed income and can’t afford an adjustable payment plan. Other situations where using a personal loan makes sense include:  

• When your credit score is good and you want to get the best possible interest rate on the money that you borrow. 
• If the amount of money that you need isn’t too high (so that it won’t be difficult for lenders to process). 

What Is a Line of Credit and How Does It Work?

A line of credit is a loan that allows you to borrow money whenever you need it, up to the limit of your line. This is a loan that you can borrow against your future income. It is usually offered by banks and credit unions. You can use the money you borrow to pay for your current expenses, purchase a car or take out a mortgage.  

If you are looking to borrow money to invest in long-term goals, such as purchasing a home or starting your own business, a line of credit might be better suited for you.  

To manage this risk and ensure a smooth repayment experience for all parties involved, many banks offer options for borrowers who want their lines paid off gradually instead of all at once. These include:  

• Monthly payments over a set period of time (e.g., 12 months). 
• A lump sum payment due at the end of said period. 

Lines of Credit: Pros and Cons

A line of credit is a revolving loan, which means that you can borrow and repay the money over time. When you take out a line of credit, you are given a lump sum of money. Once that money is paid back in full and on time, your line of credit will be closed with no further interest charged.  

Some key benefits to lines of credit include:  

• You can use it again and again – unlike personal loans where the whole amount has to be paid off at once. 
• Access to more funds – with a line of credit, you’re able to withdraw however much you need (up to your limit) when needed; you don’t have to worry about applying for another loan every time something comes up that requires extra cash. 

Some of the cons of these loans include:  

• A high credit score is required for qualification. 
• Having a persistent high balance can damage your score. 
• You may feel tempted to spend more money than you need to. 

When to Use Lines of Credit?

For many people, a personal line of credit vs a personal loan may be the most desirable option because they offer flexibility. A line of credit is a short-term loan that can be accessed at any time and as often as you need to borrow money.  

• Short-term loans: A line of credit allows you to borrow money when you need it without having to reapply for a new loan each time. This can be helpful if you plan on making multiple purchases over the course of several months and don’t want to apply for multiple loans in order to do so.  

• Accessing cash: If you have money in an account but need access immediately, it may make sense for you to use your line of credit rather than withdrawing cash directly from your bank account (which typically involves fees). Also, remember that some banks charge fees when consumers overdraw their accounts with automatic debit transactions—using one’s line of credit instead means that there will never be an overdraft fee!  
• Large purchases: If your next big purchase requires more financing than what is available through traditional lending products like mortgages or car loans, then using a large sum from one’s personal line of credit vs a loan could make sense financially especially since interest rates tend to be lower than on personal loans.  

Personal Loan vs. Line of Credit: Key Differences

Personal loans come in different rates and terms, but the basic concept is the same- you borrow money from a lender to use for a specific purpose. The main difference between personal loans and lines of credit is that personal loans are usually smaller in size, with less flexible terms and often higher interest rates. A line of credit, on the other hand, can be used for larger purchases like a car or a home.  

One key difference between a personal loan vs personal line of credit is that personal loans require you to pay back the loan in full within a set period of time, while lines of credit allow you to make payments over time. Another key difference between them is that personal loans require you to submit an application, while lines of credit often do not.

How to Decide Which Option Is Best for You

When you are considering is a personal loan or line of credit better for you, there are a few things to think about first.  

• Can you repay the loan? An unsecured loan vs line of credit will be due in full at a specific time and date, so if you can’t pay it back, it will go into collections. With a line of credit, your balance rolls over every month and doesn’t have an official expiration date—but this also means that interest compounds over time as well. So, keep that in mind when making decisions about how much money to borrow (and whether or not you’ll be able to afford the interest).  

• Are there any restrictions on what types of expenses are eligible? Some lenders may only allow funds from their line of credit account to be used for certain things—like home repairs or paying off debt—while others may have no restrictions at all! This can have a huge impact on whether or not these accounts are right for each person’s needs. Make sure that any restrictions aren’t going against what would work best for you before applying!  

Bottom Line

When it comes to choosing a line of credit vs a personal loan, there are a few key differences that you should be aware of and that we discussed in this article. Don’t forget to factor in the length of the loan, interest rate, and repayment terms best suited for you while determining which one to choose.  

Lines of credit tend to be better suited for borrowers who will want to have regular access over an extended period of time or until they reach their limit. Personal loans, on the other hand, are best for those who want to take out some money on a short-term basis but don’t need access to the funds for an extended period of time.   

In addition, some people choose to apply for both types of loans so they can have more funds than one type would allow them. If you’re thinking of applying for either type or want more information about how they work and what they’re best suited for, contact your financial advisor.