Personal Loan vs. Personal Line of Credit: What’s the Difference?

At some point, you’ll likely need or want to borrow money. Maybe you’re looking for a way to consolidate your high-interest debt, or you really want to renovate your kitchen. A personal loan and a personal line of credit are both useful borrowing options, but they work differently. 

With a personal loan, you borrow a fixed amount of money for a fixed amount of time with a fixed repayment amount. A line of credit works more like a credit card. You borrow up to a maximum credit limit and then use the funds as you need them. 

What is a Personal Loan?

A personal loan (also called an installment loan or consumer loan), allows you to borrow a fixed amount of money that is given to you as a lump sum. You are then responsible for paying back the loan over a predetermined repayment period, including interest and any fees. Your payments are called installments.

People commonly take out personal loans to renovate their homes, purchase a new car, or consolidate high-interest debts. Most personal loans range from $100 to $50,000 with a term between 6 and 60 months. How much a personal loan will cost depends on several factors, including:

• The size of the personal loan

• The interest rate on the loan 

• Other fees 

The interest rate on a personal loan can greatly impact the overall cost. You can typically choose between a variable or fixed interest rate. A fixed-rate stays the same for the term of your loan, while a variable interest rate can increase or decrease throughout the term.  

Your interest rate can also vary based on factors like your credit score, the type of lender, and the type of loan. 

There are two main types of personal loans: a secured loan, and an unsecured loan. A secured personal loan uses assets, (such as your car or house) as collateral. This is to help ensure that you will pay back the loan. If you fail to make a payment, the lender can take the asset. 

An unsecured personal loan does not require collateral but, for that reason, often comes with a higher interest rate than a secured loan because it carries more risk for the lender. 

What is a Personal Line of Credit?

With a personal credit line, you can borrow up to a maximum credit limit. You don’t have to specify a purpose for how you will use the funds, and you can use as much or as little as you need when you need it. 

Personal lines of credit are commonly used to consolidate higher-interest debt or for unexpected expenses. 

A personal line of credit functions similarly to a credit card in that you can continuously borrow and pay back the money up to the maximum limit. Unlike a personal loan, you only pay interest on the money you use. 

The interest rate on a personal line of credit is usually variable, meaning it can go up and down. Your credit score can affect the interest rate you qualify for on a personal line of credit. 

Is a Personal Loan Better Than a Personal Line of Credit?

Whether a personal loan or line of credit is best for you depends on your financial goals and how you intend to use the money. 

If you have a specific purpose for borrowing the money, such as renovating your kitchen or buying a new car, a personal loan might be the right fit. Because personal loans often come with a fixed monthly payment, they can make it easier to budget compared to a line of credit. 

However, if you need access to money but you’re not sure of the exact amount you need or precisely when or how you will use it, a personal line of credit may fit the bill. 

Is it Harder to Get a Personal Loan or a Personal Line of Credit?

To get a personal loan or a line of credit, the lender will typically want to review your income, current level of debt, as well as your credit report and score. In some cases, it might be easier to secure a personal loan over a line of credit because lenders might require a higher credit score for a line of credit. 

An unsecured loan offered by an alternative lender is typically easier to get than an unsecured loan from a bank or credit union, but tends to come with a higher interest rate. 

When Should You Not Get a Personal Line of Credit?

While a personal line of credit offers versatility and immediate access to cash, it does have some drawbacks to consider. Since a line of credit tends to come with a variable interest rate, your payments can fluctuate from month to month. If you are someone who likes to have a set monthly budget, this can make it difficult to plan for your payments. If you’ve struggled to manage credit in the past, make sure you have a plan for how you will pay back a line of credit. Like a credit card, it can be easy to wrack up debt if you are constantly borrowing from your line of credit and only making your minimum monthly payments. 

What Are The Disadvantages of a Personal Loan?

A personal loan gives you access to a lump sum amount of money. If you have a plan for how you will use the money and how you intend to pay it back, a personal loan can be a useful tool. However, if you don’t have a plan in place, it’s easy to find yourself with a pile of unnecessary debt.

If you miss a payment on a secured loan, you risk losing what you put up as collateral (possibly your house or car). Missing a payment can also lead to credit damage if the lender is reporting to the credit bureaus. 

Depending on your interest rate and any associated fees, a personal loan can get expensive. Make sure you understand exactly how much it will cost you, and consider other options like saving up money for your purchase or borrowing a smaller amount. 

Does a Personal Line of Credit Hurt Your Credit Score?

If your lender reports information about your personal line of credit to the credit bureaus, a late or missed payment can hurt your credit score. On the other hand, if you make all of our payments on time, this can help to improve your credit score. 

Taking on a personal line of credit can also impact our credit utilization (how much of your available credit you are using). This can also hurt or help your score. Increasing your available credit can help your score by lowering your credit utilization. However, if you increase your available credit and then use most of it, this can harm your credit and potentially put you in debt.

Does a Personal Loan Hurt Your Credit Score?

The same is true for a personal loan. It can hurt your credit score if you don’t make your payments on time and the lender reports to the credit bureau. 

Additionally, when you apply for a personal loan or a line of credit, most lenders will check your credit score. Hard inquiries can cause a small and temporary dip in your score. 

The Bottom Line

When comparing a personal loan and a line of credit, the one that is best suited for you will depend on why you need the money and how you intend to use it. If you have a specific purpose in mind, and want access to a lump sum of money with regular fixed payments, you might opt for a personal loan. On the other hand, if you’re looking for lots of flexibility and ongoing access to money, a line of credit might seem like a better fit.