Personal loan vs. personal line of credit: What’s the difference?

Personal loans and personal lines of credit are both meant to cover big expenses or large purchases. The difference comes in how you receive your funds. Borrowing a personal loan means receiving a lump sum when you are 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. The best one for you depends on your financial habits — and what you intend on using the money for.

Personal loans vs. lines of credit

From a broad perspective, a personal loan and a personal line of credit ultimately serve a similar purpose. A lender lets you borrow funds based on an agreement, and you can use those funds as you see fit. The biggest difference between them is the repayment terms set by the lender.

Personal loans have a fixed term that typically lasts up to seven years. Your payments each month cover a portion of the amount you borrowed — the principal — and interest. This makes them most useful for set 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 need. You only pay back what you borrow with interest, which makes personal lines of credit ideal for home improvement projects or covering unexpected bills.

The other major difference between personal loans and lines of credit is the interest you pay. Personal loans tend to have fixed interest rates. A line of credit may have a variable rate during its draw period, followed by a fixed rate once that period ends.

Overall, personal loans and personal lines of credit are similar products. If you know how you need to use the funds, you can pick between predictable repayments and flexibility.

Personal loans

Personal loans give you a fixed amount of funding distributed in a lump sum, usually between $1,000 to $50,000. In most cases, your payments with a personal loan will be the same each month because they have fixed interest rates. Repayments are made monthly and last anywhere from one to seven years, though 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 in interest.

Personal loans are normally used for:

• Paying down credit card debt
• Paying for a wedding
• Financing a large purchase

Pros

• Funding in one lump sum
• Consistent payment amount
• Fixed interest
• Fixed repayment timeline

Cons

• Higher interest rates
• Potential fees and penalties
• Monthly payments are higher than credit cards
• Stricter eligibility requirements

Personal lines of credit

Personal lines of credit are an unsecured revolving credit line, similar to a credit card. They have variable rates, which are usually pegged to the prime rate. Unlike a personal loan, lines of credit rarely stretch to more than $20,000, and lenders will set your limit based on your income and other aspects of your finances.

A line of credit could be an ideal solution if you’re trying to manage purchases and aren’t clear on the overall scope of the costs. While your payments on a personal line of credit will change due to variable interest rates, you’ll pay interest only on the portion of the credit line that you use. Personal lines of credit may be available from your community bank or through a variety of online lenders.

Personal lines of credit are normally used for:

• Home improvement projects
• Overdraft protection
• Emergency situations

Pros

• Pay for only what you use
• Lower interest rates than credit cards
• Ongoing access to funds
• Funds can be used for nearly 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 similar flexibility as lines of credit — with added benefits. Using your home’s equity can also be a good way to secure a much more favorable interest rate.

• Credit cards: The best credit cards offer benefits like cash back or travel points when you spend. While their rates are higher than personal loans or LOCs, you can avoid interest by paying off your balance before the due date.
• Home equity loans: A home equity loan uses the equity in your property as collateral. Secured loans tend to have lower rates, but because they act like a second mortgage, you could lose your home if you default.
• HELOCS: A HELOC, or home equity line of credit, works similarly to a home equity loan. It uses collateral, but like a personal line of credit, you borrow what you need and only pay interest on that amount.
• Cash advances: While cash advances have higher rates than simply using your credit card, they can come in handy if you only need a small amount. However, consider another alternative first to avoid hefty fees.
• 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 convenient, they can lead to overspending.

Bottom line

Personal loans and lines of credit serve a similar purpose but function differently. A personal loan provides a single lump sum with fixed monthly payments. A line of credit offers ongoing access to funds and comes with variable rates.

Compare both options carefully, and look for lenders that fit your needs. The best choice for you will depend on your current finances and how you want your repayments to look.