Personal Loan vs. Personal Line of Credit: What’s the Difference?
If you need to borrow money, lots of banks of personal loans and personal lines of credit that you might be able to use. These types of credit are highly flexible.
Unlike mortgages or auto loans, which can only be used for specific purposes, you can use the money from a personal loan or line of credit for almost any purpose.
This flexibility makes personal loans and lines of credit incredibly popular among borrowers.
Despite their similar names and the fact that they share their flexibility, personal loans and personal lines of credit are two different things.
Understanding the difference can help you decide when you should apply for each.
What is a Personal Loan?
A personal loan is a simple loan, much like other types of loans.
You apply for the personal loan, and if you’re approved, the lender gives you a lump sum of cash. You can then use that money for whatever purpose you’d like.
Personal loans are common options for:
When you get a personal loan, you choose a term for the loan.
This is how long it will take the repay the loan if you follow the minimum payment schedule.
Usually, terms range from 3 to 5 years, though some lenders offer terms as long as 7 years or more. This lets you customize the monthly payment of the loan.
Typically, personal loans have fixed interest rates, so borrowers can predict the monthly payments for the life of the loan.
Can be unsecured and secured
Most personal loans are unsecured, meaning you don’t have to offer any form of collateral when you apply. This can make them more difficult to qualify for if you have poor credit but means you don’t have to have an asset to put at risk.
Some lenders offer secured personal loans which can be easier to qualify for and charge lower interest rates.
However, these require some form of collateral, such as the balance of a bank account, before you can apply.
What is a Personal Line of Credit?
A personal line of credit is a source of cash that you can draw from, but that you can also leave alone when you don’t need it.
It's very much like a credit card.
With a line of credit, you can borrow cash instead of using them to make purchases at stores.
If you need money, you can tap your line of credit. You’ll start getting bills until you pay the balance down. If you don’t need to borrow, you can leave the line of credit alone.
A line of credit is a revolving credit account. Typically, it stays active and available until the account is closed (either by you or the lender).
There is no set repayment period.
Your monthly payment will depend on the balance, which can vary from month to month.
Can come in many forms
Some banks offer personal lines of credit as a form of overdraft protection, but many offer them as a basic loan product.
A related loan product is the home equity line of credit (HELOC), which turns the equity you’ve built in your home into a line of credit you can tap for cash as you need it.
Personal lines of credit tend to have higher rates and lower loan maximums than HELOCs but can still be useful for emergency funding purposes if you’ve exhausted your emergency fund.
A personal line of credit can be a backup to your emergency fund -- it should not replace your emergency fund.
Which One Should You Use?
Personal loans and lines of credit are similar but have very different uses.
When to get a personal loan
Personal loans are most useful when you need to borrow a sum of money all at once.
If you’re making a large purchase, paying an unexpected bill, or consolidating debt, you need to have all the cash at one time to meet your needs.
Personal loans offer lump-sum payouts, making them best for this kind of situation. In general, if you already know what you’re going to use the money for, a personal loan is probably the right choice.
When to get a personal line of credit
Personal lines of credit are more flexible than personal loans, giving you access to cash multiple times and only as you need it.
If you have variable expenses and want to have some backup funds available beyond your emergency fund, a personal line of credit gives you that extra access to cash.
In general, if you don’t know how much you’ll need to pay or what you’ll be paying for, but want to have an easy way to borrow money when you need it, a line of credit will fit the bill.
Your Credit Score Matters
As with any situation where you borrow money, both personal loans and personal lines of credit involve lenders checking your credit.
The better your credit score, the better your chances of qualifying for the loan or line of credit.
Good credit means higher borrowing limits and lower interest rates, making loans cheaper.
If you have poor credit, you might not qualify for a loan or line of credit at all. If you do, you’ll likely have to pay higher interest rates or accept a secured loan or line of credit instead of an unsecured one.
Make sure that you always make the minimum payment on your loans and credit cards.
If you do this, you’ll build a strong payment history, which can help your credit score improve over time.