Personal loans and personal lines of credit are two ways to borrow money that usually don’t require collateral. However, they are functionally different. A personal loan offers you a sum of money up front and requires fixed monthly payments throughout the life of your loan. A personal line of credit, on the other hand, allows you to withdraw as much money as you need at any one time and pay it back on your own schedule with a variable interest rate.
Personal loans and personal lines of credit can be a good way to borrow money; the best for you depends on your financial habits.
Personal loan vs personal line of credit
Generally speaking, a personal loan and a personal line of credit ultimately serve a similar purpose. A lender allows you to borrow funds on the basis of an agreement, and you can use those funds as you see fit. The biggest difference between a personal loan and a personal line of credit is the terms of each type of loan.
Personal loans are a type of loan that gives you a fixed amount of financing divided into a lump sum. They are generally used for one-time expenses. Your payments with a personal loan will be the same every month because they have fixed interest rates and a fixed repayment schedule. You can get a personal loan from a local bank, credit union, or online lender.
Personal loans are normally used for:
To take with: Personal loans are ideal when you are considering a large one-time purchase and want predictable monthly payments.
Personal lines of credit
A personal line of credit, like a credit card, is an unsecured revolving line of credit with a credit limit and a variable interest rate. If you’re trying to manage your purchases and aren’t clear on the overall magnitude of the costs, a personal line of credit might be an ideal solution. Although your payments on a personal line of credit 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 community bank or from various online lenders.
Personal lines of credit are normally used for:
To take with: If you don’t know how much or how often to borrow, a personal line of credit can be a flexible lending option.
The Greatest Similarities Between Personal Loans and Personal Lines of Credit
Although a personal loan and a personal line of credit are different, they share several similarities:
- Both require interest payments
- The request will result in a credit check for approval, which means your credit score will be affected.
- The basic requirements for a personal loan and a personal line of credit are generally the same.
- Most personal loans and lines of credit are unsecured, which means you don’t need to use an asset like your home or car as collateral. This makes it a slightly less risky option than a home equity loan.
The biggest differences between personal loans and personal lines of credit
Personal loans and personal lines of credit also have several important differences:
- Personal lines of credit usually have higher interest rates because they carry a higher risk from the lender.
- Interest rates with a personal line of credit are variable, unlike those with personal loans, which are determined during the application process and remain fixed throughout the life of the loan.
- Perhaps the biggest difference is how you receive and repay the funds. Rather, a personal line of credit acts like a credit card, with a “revolving” line of credit and accrued interest on any outstanding balance. You can withdraw money as needed, but you will need to make minimum monthly payments just like you would with a credit card. A personal loan, on the other hand, gives you the full loan amount up front. You will then repay the loan in monthly installments over a defined repayment period.
How to determine which option is right for you
Before choosing between a personal loan and a personal line of credit, determine your level of need. Each loan product has its unique advantages, and you’ll want to choose the one that’s best for your situation.
If you’re not sure exactly how much money you’ll need to borrow, a personal line of credit might be an ideal solution. It is best suited for day-to-day expenses, like an unpredictable home repair project. Like a credit card, you only pay interest on the part of your credit limit that you actually use. Remember, personal lines of credit charge variable interest rates. This means that your monthly payment due will vary, as will the total interest charges that you might accumulate.
In contrast, personal loans offer fixed interest rates that do not change during the life of the loan. This means that you can expect the same amount of payment due for each installment, making it easier to manage your finances. Personal loan funds are also distributed in a lump sum, so they are usually best for large one-time expenses like paying off credit card debt, financing a large purchase, paying for a wedding. or the repayment of student loans.
The bottom line
Whether you’ve chosen a personal loan or a personal line of credit, it’s important to know your credit rating to get an idea of what loans you may be eligible for. You can request a free credit report through AnnualCreditReport.com to review your credit history before submitting a request to a lender. Then compare quotes from a few different lenders to see which one will give you the best deal.