Choosing between a personal loan and a personal line of credit depends on your financial goals and borrowing needs. Personal loans offer lump-sum funding with predictable payments, while lines of credit provide flexible access to funds for ongoing expenses. This guide compares their key features, pros, and cons to help you make the best decision for your situation.
Editor
Zarina S
Update 13.01.2025
When you have a big expense to pay for, figuring out how to pay for it can be overwhelming. Two popular options are a personal loan and a personal line of credit, each with its benefits. Which one is right for you depends on how and when you’ll use the money. Knowing the difference between the two can help you make a smart choice and save.
What Is a Personal Loan?
A personal loan is an unsecured loan that gives you a lump sum of money, used for big one-time expenses like home renovations, medical bills, or debt consolidation. The key features of personal loans are that they are repaid in fixed monthly installments over a set term, usually 1 to 7 years. Since personal loans are structured and stable, they’re a good option for borrowers who like predictable payments.
The loan amount can vary, most loans are from $1,000 to $100,000. Personal loans have fixed interest rates, which means your monthly payments will be the same throughout the loan term, so you can plan your finances accordingly. Personal loan interest rates in the U.S. can range from 4.99% to 36% depending on your credit score and the lender’s terms.
Types of Personal Loans
Secured personal loan. A secured personal loan requires collateral, like a car or savings account, to secure the loan. If you default, the lender can take the collateral to recover the loan amount. These loans have lower interest rates since the risk is lower for the lender.
Unsecured personal loan. An unsecured personal loan doesn’t require any collateral. Instead, your creditworthiness is the determining factor for eligibility and interest rates. These loans have higher interest rates since the lender takes on more risk.
Debt consolidation loan. This type of personal loan is used to combine multiple high-interest debts into one loan with a lower interest rate. It simplifies repayment by combining multiple payments into one monthly payment.
Co-signed loan. A co-signed personal loan is when a second party agrees to pay the loan if the primary borrower defaults. This type of loan is available to those with lower credit scores since the co-signer provides extra security to the lender.
Fixed-rate loan. A fixed-rate personal loan has an interest rate that’s the same throughout the loan term. This is predictable since your monthly payments won’t change, so you can budget more easily.
Variable-rate loan. A variable-rate personal loan has an interest rate that can change over time, usually tied to an index like the prime rate. While the initial rate may be lower than a fixed-rate loan, it can increase during the loan term and affect your monthly payments.
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What Is a Personal Line of Credit?
A personal line of credit is a flexible borrowing option that gives you access to a set credit limit. You can draw funds as needed up to the approved limit and repay the borrowed amount over time. The credit line remains open for ongoing use as long as you make the required payments.
The typical term for a personal line of credit is 1 to 5 years, with the option to renew or extend the credit limit upon maturity. Repayments are usually based on the amount borrowed and interest is only charged on the funds used, not the entire credit limit.
One of the best things about a personal line of credit is its flexibility. Like a credit card, you can withdraw, repay, and borrow again without reapplying. This revolving nature makes it perfect for ongoing expenses or emergency needs and gives you more control over when and how much to borrow.
Note! Some credit lines can also be used as checking accounts, you can make purchases or payments via a linked debit card or by writing checks.
Types of Lines of Credit
Unsecured line of credit. This type of line of credit doesn’t require any collateral, like property or assets, to secure the loan. Approval is based on your creditworthiness, income, and financial history.
Secured line of credit. A secured line of credit requires collateral, like a savings account or home equity, to back the loan. The collateral reduces the risk for the lender, so often has lower interest rates than unsecured lines of credit.
Personal line of credit. This is the most common type of line of credit for individuals, used for general purposes like debt consolidation, unexpected expenses, or home improvements. It can be secured or unsecured depending on your financial profile.
Home equity line of credit (HELOC). A HELOC is a secured line of credit that uses your home equity as collateral. It often has higher credit limits and lower interest rates than unsecured lines of credit, so it’s perfect for bigger, long-term expenses like major home renovations or education costs.
Business line of credit. A business line of credit is for small businesses, offering flexible borrowing to cover operating expenses, manage cash flow, or invest in growth. It can be secured or unsecured and is based on the business’s financials, not the owner’s credit.
How Are Personal Loans and Lines of Credit Similar?
Unsecured options. Both personal loans and lines of credit can be unsecured, meaning no collateral is required. Approval is based on your creditworthiness, income, and financial history.
Usage flexibility. Both personal loans and lines of credit offer flexibility in how the funds can be used. They can be used for various expenses like medical bills, home renovations, or debt consolidation.
Credit score impact. Both affect your credit score. Timely payments can improve your credit score, missed payments can damage it. Proper management of either option will contribute to a good credit history.
Eligibility requirements. In both cases, lenders generally look for the same financial criteria, a good credit score, stable income, and an acceptable debt-to-income ratio to determine eligibility and interest rates.
How Are Personal Loans and Lines of Credit Different?
Loan structure. A personal loan gives you a lump sum of money, and a line of credit gives you a revolving credit line you can borrow from, repay, and borrow from again as needed. However, some lines of credit may be non-revolving, where once the credit is paid off, the line cannot be used again.
Repayment terms. Personal loans have fixed repayment terms, usually 1 to 7 years. Payments are scheduled and include both principal and interest. A line of credit has flexible repayment terms. You must make at least the minimum monthly payment, which is based on the amount you borrowed. The bank sets a repayment period within which the full amount must be paid off, but you can pay more than the minimum if you want.
Interest rates. Personal loans have fixed interest rates, meaning the rate stays the same for the entire loan term, some may have variable rates. Lines of credit have variable interest rates which can change based on the lender’s prime rate, some may have fixed rates. This means with a line of credit, your payments can either fluctuate or remain the same depending on the type of rate.
Usage flexibility. Personal loans are good for specific one-time expenses, like debt consolidation or a big purchase. A line of credit is more flexible, you can borrow, repay, and borrow again as needed, just like a credit card. So it’s good for ongoing or unpredictable expenses like home renovations or emergency costs.
The interest rate is fixed for the entire loan term so you can predict total repayment costs and avoid surprise changes in monthly payments.
Personal loans have larger borrowing limits which is good for big one-time expenses like home renovations, medical bills, or debt consolidation.
Cons
Since personal loans have fixed repayments over a set period, you have less flexibility to adjust payments if your financial situation changes.
Interest is charged on the entire loan amount from the start so you may end up paying more interest in the long run.
You have to repay the full loan amount even if you don’t need all of it.
Lines of Credit Pros and Cons
Pros
You can use the funds as needed.
Interest is charged only on the amount you borrowed, so if you repay quickly you can minimize interest costs.
Once the balance is paid off you can borrow again, so it’s good for ongoing or unpredictable expenses.
Cons
Lines of credit have variable interest rates which can increase over time, so your monthly payments can fluctuate.
Since you can borrow again, it’s easy to keep borrowing and end up in debt if not managed well.
Requires good to excellent credit.
How to Choose Between Line of Credit and Personal Loan
When choosing between a line of credit and a personal loan, consider your financial needs, repayment preferences, and the type of expense you want to cover. Both have their advantages, so understanding the differences can help you choose the right one for you.
When to Get a Personal Loan
Debt consolidation. If you have multiple high-interest debts, consolidating them into one personal loan with a lower interest rate will simplify your payments and save you interest in the long run.
Home renovations. For big home improvement projects that require a fixed budget, a personal loan gives you the funds with fixed payments.
Big purchases. Personal loans are good for big, planned purchases like buying a car, paying for a wedding, or other big-ticket items that don’t fit into your monthly budget.
Medical bills. If you have unexpected medical bills that you can’t pay off immediately, a personal loan will give you the funds and clear repayment terms.
Moving costs. Whether you’re moving for work or other reasons, a personal loan can cover the moving costs including deposits, transportation, and temporary housing.
When to Get a Line of Credit
Ongoing or variable expenses. A line of credit is good for expenses that vary month to month, like home repairs, utilities, or seasonal business costs.
Emergency funds. If you need access to funds for immediate situations, a line of credit allows you to borrow only what you need, when you need it.
Cash flow management for businesses. Small businesses can use a line of credit to cover operational costs during slow periods, so you don’t need a fixed-term loan.
Short-term borrowing. For borrowers who only need funds for a short period and don’t want to commit to long-term repayments, a line of credit gives you flexibility without locking in repayment schedules.
Debt management. If you have existing debts and want to pay them off gradually, a line of credit allows you to borrow only as needed, so it’s easier to manage your repayments without deadlines.
Conclusion
There’s no one-size-fits-all when it comes to choosing between a personal loan and a line of credit. Both have their advantages and are good for different situations. The right one depends on your financial goals, your need for flexibility or predictability, and your credit score. Make sure to consider how each will impact your finances to choose the best one for you.
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FAQ
What are other alternatives to personal loans and lines of credit?
Before you choose a loan, make sure to explore other options and know the pros and cons. For example, if you’re considering a Personal Line of Credit, compare it with credit cards to see which one suits you better. If you only need a small amount for a short period, a paycheck advance app might be a better option. In some cases, saving up for your goal might be the most cost-effective option, so make sure the funding option you choose fits your financial situation and goals.
How does my credit score affect my eligibility for a personal loan or line of credit?
Your credit score is a big factor in determining if you qualify for a personal loan or line of credit. If your credit history is not good, you may not be eligible for a Personal Line of Credit. In that case, you might need to consider a fair credit loan, which could have higher interest rates or stricter terms.
What’s the application process for a personal loan or line of credit?
The application process for both personal loans and lines of credit is the same. Lenders will review your credit report, score, income, and assets to assess the risk of lending to you. The better your credit, the higher the chance of approval. But with a personal loan, you need to decide upfront how much you want to borrow while with a line of credit, you have ongoing access to funds up to a certain limit.
