Personal Line of Credit vs. Personal Loan: Key Differences

A personal loan or a line of credit are viable options if you need to borrow money. Both are typically unsecured and can be used for different purposes, such as debt consolidation or covering large expenses. We compare personal lines of credit and loans to help you understand which is best for your financial situation.

Personal line of credit versus personal loan: key differences

What is a personal line of credit?

A personal line of credit is a type of revolving debt; you can pay down your balance and draw funds multiple times with a single loan. Personal lines of credit are typically unsecured, so you don’t have to provide collateral. However, lenders may be willing to offer a lower interest rate for borrowers who attach a valuable asset to the loan. Sometimes, borrowers with poor credit scores may only be approved if they provide collateral.

A personal line of credit works like a credit card. But, depending on the lender and terms, you can qualify for more favorable terms than a credit card, including a lower interest rate. This product may be helpful if you’re financing a longer-term project, such as a home renovation, where you must make large purchases several times.

Note that a personal line of credit differs from a home equity line of credit (HELOC). While the draw and repayment rules are similar, a HELOC is secured by a residence, which lowers the lender's risk—and typically comes with a lower interest rate than an unsecured loan.

How does a line of credit work?

You can borrow and repay the loan multiple times with a line of credit. Here’s a brief look at how a line of credit works:

Application and approval

You can apply for a personal line of credit through a financial institution, such as a bank or online lender. During this process, the lender evaluates your credit score, income, and other financial details to determine your creditworthiness and the maximum credit limit they will offer.

Credit limit

If approved, you are granted a maximum borrowing limit. You can borrow up to the limit, but you don’t have to. You can borrow as much or as little as you need to, up to this limit.

Draws and usage

You can draw from your line of credit at any time to cover expenses, such as home repairs and emergency costs, or to smooth out cash flow when income is irregular. Unlike a traditional loan, you only pay interest on the amount you actually borrow, not the total credit limit.

Interest and payments

Interest rates on personal lines of credit are usually variable, which means they can change over time. The regular monthly payments usually cover the interest—and may include a portion of the principal amount. You can repay and re-borrow within your credit limit as needed. Some loans offer a fixed interest rate on all drawn funds, but the rate is still variable for future draws.

Revolving access

A personal line of credit is often revolving, which means that as you repay the borrowed amount, your available credit increases by the repayment amount. This cycle can continue throughout the line of credit's life until the lender closes it (or you decide to end it).

Line of credit pros and cons

Weighing these pros and cons can help you decide if a personal line of credit suits your financial situation.

What is a personal loan?

A personal loan is an unsecured installment loan. Personal loans have a fixed interest rate, and payments are fixed until the loan is paid off.

Similar to a credit card (another type of unsecured line of credit), a personal line does not require collateral; you don’t need to attach a personal asset, such as a home or a car, to the loan. Because this is riskier for the lender, you’ll likely have to pay a higher interest rate than a secured installment loan.

It’s important to pay close attention to fees and interest rates; common fees include origination fees, early payoff penalties, and late charges. But if you’re okay with the costs, personal loans have the advantage of being very predictable because you know exactly what you’ll pay every month—and when it will be completely paid off.

How does a personal loan work?

Personal loans are simple and predictable, but knowing what you’re getting into when signing up is important.

Application and approval

If you’re looking for a personal loan, start by applying for a personal installment loan with a bank, credit union, or online lender. The application process typically involves checking your credit history, verifying your income, and evaluating other financial commitments. This information helps lenders determine whether to approve you for the loan and the loan terms.

Loan amount and terms

If approved, you will receive a fixed amount of money. The loan terms, including the interest rate and repayment period, are set based on your creditworthiness and the lender’s policies. These loans usually feature a fixed interest rate, and your payment amount remains consistent throughout the loan period.

Receiving funds

After approval—and signing the loan agreement—the funds are deposited into your bank account in one lump sum. You can use these funds for various purposes, such as consolidating debt or financing a large purchase.

Repayment schedule

Repayment is made through regular monthly installments over a set term. Each payment includes part of the principal amount and interest. A predictable payment schedule can help with budgeting because you know the exact payment amount each month. If you make additional or larger payments, you can pay off your loan early and save on interest costs.

Closing the loan

The loan is closed once the balance decreases to zero. Completing all monthly payments can improve your credit score because it reflects your ability to manage and repay debt effectively.

Personal loans pros and cons

When is a line of credit the right choice?

Personal lines of credit offer a flexible borrowing option that can be particularly beneficial for managing fluctuating expenses or funding ongoing projects. With a line of credit, you have access to a sum of money you can draw from as needed. This makes it easy to handle expenses as they arise—without the need to take out multiple loans.

Interest-only payments are another flexible feature of a personal line of credit (although it doesn’t help you pay off debt). You can control how much of the credit line to use and adjust your borrowing according to your financial needs.

Personal lines of credit might not be suitable for individuals who lack financial discipline. The easy access to money can lead to overspending, making it difficult to manage your finances responsibly. It is important to assess your financial habits before opting for this type of credit facility.

When is a personal loan the right choice?

Personal installment loans are ideal for handling specific, one-time expenses that require immediate funding. These can include major purchases, such as buying a car, consolidating debt, or covering significant medical expenses. Personal loans provide the funds you need upfront, making it easier to tackle large costs immediately.

Other advantages include their fixed repayment terms and consistent monthly payments. This makes it easier to budget, and you know that your debt will be paid off within a predetermined period.

Personal loans may not be the best choice if you anticipate the need to borrow more funds in the future. Since installment loans don’t revolve, you must apply for a new loan to access new funds. This may be less convenient than other forms of credit, where you can draw repeatedly up to a certain limit.

TIME Stamp: When choosing between a personal line of credit and loan, consider your financial needs

When comparing a personal line of credit versus a personal loan, consider your financial needs, the total cost, and ability to repay the loan as agreed. Will you need all of the funds upfront, or can you draw money over a longer period. If you find the right product for your situation, a personal loan or personal line of credit can be a sensible choice.

Frequently asked questions (FAQs)

What's the difference between a personal loan and a personal line of credit?

A personal installment loan is for a fixed amount and has a consistent monthly payment. A personal line of credit works like a credit card: You can draw funds and repay the balance multiple times up to the account’s limit.

Is a line of credit or a loan better?

There’s no best option for all borrowers. A fixed personal loan is often better for one-time needs, while a line of credit is better for ongoing projects or households with variable income and situations where you’ll need to draw funds several times.

Is it easier to get approved for a loan or line of credit?

The best way to get approved for a personal loan or line of credit is to demonstrate that you’re responsible with credit and can afford the loan. Your credit score and debt-to-income ratio (DTI) are two of the most important loan approval requirements.

What is cheaper—a loan or a line of credit?

The cost of a personal loan and a personal line of credit varies based on the interest rate and fees. Depending on your rates and repayment schedule, you may find either on to be cheaper.