- A line of credit allows you to borrow against your available credit as needed during the draw period. When the draw period is over, you must start repaying the balance.
- A personal loan allows you to borrow a lump sum and pay it back in fixed installments.
- Personal lines of credit tend to be more flexible than personal loans when it comes to borrowing and repayment, but personal loans can be more affordable.
When you need to borrow money, you have many choices for how to go about it. Two popular options include a personal line of credit and a personal loan. They might sound like the same thing, but there are important differences.
Read on to learn about the difference between a personal line of credit versus a personal loan and which one might be best for you.
Inside this article
Line of credit definition
A personal line of credit (PLOC) is a type of revolving credit that works similarly to a credit card. It’s a set amount of money that you can borrow against, up to the limit, for a certain timespan (known as the draw period). You can borrow funds as needed, and any payments made toward the balance replenish your available credit. Interest is charged on the balance as well.
A line of credit has a flexible repayment schedule with the option to make interest-only monthly payments, said Eric Presogna, founder and CEO of One-Up Financial, an advising firm. However, once the draw period is up, you must begin repaying the balance and you can’t borrow any more money.
Personal loan definition
A personal loan is similar to a line of credit in that you can borrow money to use just about however you like. The major difference between the two is the structure of repayment, according to Presogna.
“A personal loan will have a definitive term and require monthly payments of principal and interest,” he says. Personal loans are considered installment loans, meaning you’re given a single, lump sum of money that you pay off in regular installments over time.
Rates are also typically lower for personal loans. The average interest rate for a two-year personal loan is 8.73% as of May 2022, according to the Federal Reserve.
“Both require personal guarantees by the borrower, meaning their personal assets are on the hook if they default,” says Presogna.
When is it best to use a line of credit?
Presogna explained that a personal line of credit is ideal to have on hand for financial emergencies and unexpected major expenses, since you can borrow money on an as-needed basis. Plus, you only pay interest on the amount you use.
For example, say your mechanic hands you a $4,000 bill for repairs to your car. “Instead of putting that on a credit card with an APR of 18%, a personal line might be a better solution as…interest rates are much more reasonable when compared to credit cards.”
When should you use a personal loan instead?
Even though you can use a personal loan to finance just about anything, it’s not necessarily a good idea to do so. There are certain situations when a personal loan can be beneficial.
For example, a personal loan can be used to consolidate higher-interest debt. If you have several outstanding credit card balances with double-digit interest rates, you can save quite a bit of money by using a personal loan to consolidate that debt into a single monthly payment with a lower average APR.
Personal loans are also often used to finance home renovations, major personal events such as weddings and other one-time fixed expenses.
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How to shop around for a personal loan or line of credit
Regardless of which option you choose, it’s important to spend some time comparing offers before borrowing money. There are several factors you should evaluate before making a decision, including:
Interest rate: One of the biggest factors that contributes to the cost of your personal loan or line of credit is the interest rate. A higher rate can mean paying hundreds or thousands of dollars in extra interest charges. Interest rates are largely based on your credit score, so be sure your credit is in good shape before applying.
Fees: Also pay attention to the fees involved in borrowing money. Personal loans, for example, can carry origination fees of up to 8% of the borrowed amount. Beyond that, are there closing costs? Prepayment penalties? Try to work with a lender that charges minimal fees.
Term: You’ll also need to select a loan or line of credit that works for your borrowing needs. A short repayment term will allow you to pay back your debt more quickly, but it will have higher monthly payments. A longer term will give you more breathing room on a monthly basis, but will result in more interest paid over time.
Lender: You also have many choices when it comes to where you borrow money. Banks and credit unions are a solid option, as are many online lenders. Sound Dollar reviewed popular lenders of personal loans found the following to be among the best options available: