Key learning points
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Personal loans are best for one-time, fixed expenses.
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Personal lines of credit are best for projects or purchases that require flexibility.
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Both options offer lower average rates than credit cards for borrowers with good credit.
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The repayment terms depend on how much you borrow and the length of your term.
Personal loans and personal lines of credit are both intended to cover major expenses or large purchases. The difference is in the way you receive your money. Borrowing a personal loan means you’ll receive a set amount of money when you’re approved, while a personal line of credit functions similarly to a credit card.
Both personal loans and personal lines of credit can be a good way to borrow money. Which one is best for you depends on your financial habits – and what you want to use the money for.
Personal loans vs. personal line of credit
From a broad perspective, a personal loan and a personal line of credit ultimately serve a similar purpose. A lender allows you to borrow money based on an agreement, and you can use that money as you see fit. The biggest difference between the two is the repayment terms set by the lender.
Personal loans have a fixed term that is usually up to seven years. Your monthly payments cover part of the loan amount (the principal) and the interest. This makes them especially useful for fixed expenses, like a wedding or debt consolidation, where you know exactly how much you need to spend.
A personal line of credit does not have a fixed term. Instead, it has a draw period that allows you to borrow against your credit limit whenever you want. You only pay back what you borrow with interest, making personal lines of credit ideal for home improvement projects or paying unexpected bills.
The other major difference between personal loans and lines of credit is the interest you pay. Personal loans usually have a fixed interest rate. A line of credit can have a variable interest rate during the draw period, then switch to a fixed interest rate once that period is over.
| Personal loans | Lines of credit | |
|---|---|---|
| How money is spent | Lump sum upon approval | If necessary during the draw period |
| Average interest rates | 10%-32% | 8%-32% |
| Type of interest | Fixed | Variable |
Overall, personal loans and personal lines of credit are similar products. Knowing how to use the money gives you the choice between predictable repayments and flexibility.
Personal loans
Personal loans are ideal when you are planning a large one-time purchase and want predictable monthly payments.
Personal loans give you a fixed amount of financing distributed all at once, usually between $1,000 and $50,000. In most cases, your payments on a personal loan are the same every month because they have a fixed interest rate. Repayments are made monthly and last from one to seven years, although some lenders may offer longer terms.
You can get a personal loan from a local bank, credit union, or online lender. The best rates are usually reserved for borrowers with good credit, usually a score of 670 or higher. However, there are bad credit personal loans available – just expect to pay more interest.
Personal loans are normally used for:
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Pay off credit card debt.
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Paying for a wedding.
- Financing a major purchase.
Plus points
- Financing in one go
- Consistent payment amount
- Fixed interest
- Fixed repayment timeline
Cons
- Higher interest rates
- Loan costs and penalties
- Monthly payments are higher than credit cards
- Stricter eligibility requirements
Personal lines of credit
Takeaway: A personal line of credit offers flexibility if you’re not sure how much to borrow or how often.
Personal lines of credit are an unsecured revolving line of credit, similar to a credit card. They have variable rates, which are usually linked to the main rate. Unlike a personal loan, lines of credit rarely extend beyond $20,000, and lenders will determine your limit based on your income and other aspects of your finances.
A line of credit can be an ideal solution if you are trying to manage your purchases and are not clear about the total amount of the costs. Although your payments on a personal line of credit will change due to variable interest rates, you will only pay interest on the portion of the line of credit that you use. Personal lines of credit may be available from your local bank or through various online lenders.
Personal lines of credit are normally used for:
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Home improvement projects.
- Protection against overshoot.
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Emergencies.
Plus points
- Only pay for what you use
- Lower interest rates than credit cards
- Continued access to funds
- Funds can be used for almost any purpose
Cons
- Variable interest rate
- Fluctuating repayment amount
- Potential to overspend
- Strict eligibility requirements
Alternatives to personal loans and lines of credit
While personal loans and personal lines of credit are useful financial tools, they won’t always be the right choice. Credit cards offer the same flexibility as lines of credit, with additional benefits. And using the equity in your home can be a good way to get a much more favorable interest rate.
- Credit cards: The best credit cards offer benefits like cash back or travel points when you spend money. Although their rates are higher than personal loans or LOCs, you can avoid interest by paying off your balance before the due date.
- Mortgage loans: With a mortgage loan, the equity in your home is used as collateral. Secured loans typically have lower rates, but because they act like a second mortgage, you could lose your home if you default.
- HELOC’S: A HELOC, or home equity line of credit, works the same way as a home equity loan. Collateral is used, but like a personal line of credit, you borrow what you need and only pay interest on that amount.
- Cash advances: Although cash advances have higher rates than just using your credit card, they can come in handy when you only need a small amount of money. However, consider another alternative first to avoid high costs.
- Buy now, pay later: Buy now, pay later (BNPL) apps and services give you access to flexible, interest-free financing when you make a purchase. But while they are convenient, they can lead to overspending.
it comes down to
Personal loans and personal lines of credit serve a similar purpose, but function differently. A personal loan consists of one fixed amount with fixed monthly payments. Aline of Credit offers continuous access to funds, but with variable rates.
Compare both options carefully and look for lenders that meet your needs. The best choice for you depends on your current finances and what you want your repayments to look like.
