Personal Loan vs. Line of Credit: What’s the Difference and Which Is Better for You?

If you have a big upcoming expense that needs extra cash, you might be choosing between a personal loan and a line of credit. Personal loans give a lump sum of money upfront, while a line of credit allows access to funds over time.

This guide will walk you through both options so you can decide which is best for you.

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Personal Loan vs. Line of Credit at a Glance

Personal loans provide borrowers with an upfront lump sum of money that can be used for any purpose, such as debt consolidation or home improvements. Once your loan is opened, you'll make fixed monthly installment payments over a set period, and up to several years. 

On the other hand, a personal line of credit (PLOC) is similar to a credit card. You’re given a revolving credit line and can access funds, up to your credit limit, during the draw period, which might vary depending on the loan terms. However, unlike personal loans, most PLOCs have variable interest rates that fluctuate based on the Prime rate.

Both options are excellent ways to access the funds you need, but your choice will depend on your needs.

Choosing which option is best for you depends on the following:

• If you need a single, fixed amount of cash with regular monthly payments, then you might consider a personal loan.

• If you prefer having a line of credit that allows you to access cash when needed and are comfortable with variable interest rates, then a personal line of credit might be the best option.

How a Personal Loan Works — and When It Makes Sense

Here's a breakdown of how a personal loan works so you can understand if it makes the most sense for you.

About Personal Loans and Repayment Periods

Personal loans provide a single lump-sum cash payment ranging from $10,000 to $50,000. However, some lenders are willing to offer up to $100,000 to highly qualified borrowers, such as Truist. Because personal loans have fixed interest rates, your monthly payments will stay consistent.

Most lenders allow you to choose your repayment period, which can be anywhere from two to seven years, at lenders like LightStream. Generally, the longer your loan term, the higher your interest rate will be.

Personal loans are offered by banks, credit unions and online lenders. While the best rates are usually available to borrowers with credit scores over 650, there are also personal loans for those with lower credit scores. However, these loans tend to have higher interest rates.

When Would a Personal Loan a Better Choice?

Personal loans are usually the best option when you need a specific amount of money and want predictable monthly payments. Some situations where a personal loan would make sense include:

• Debt consolidation with a clear payoff timeline

• Major planned expenses, like a medical procedure or relocation

• When you want more structured payments

• Anyone who qualifies for a low interest rate

You should know that personal loans can have a wide range of interest rates. If you have excellent credit, your interest rate could be below 10%, which is much better than the average credit card. But if your credit isn't ideal or you're looking to borrow a large amount of money, the interest rate could be as high as 30% or more.

To fully understand when using a personal loan would make the most sense, here's an example. 

Last year, you lost your job and struggled to find work. Unfortunately, you used up your emergency fund and had to rely on credit cards to cover expenses. Throughout the year, you accumulated an $8,000 balance on two different cards, both with an interest rate of 27.99%.

Luckily, your high credit limit kept your debt-to-income ratio low, so it hasn’t significantly affected your good credit score. Now that you've found work, you want to pay off your card balances more quickly. A personal loan could be a good option because it might lower your interest rate and allow you to choose a term that results in monthly payments you can afford. Choosing this route will help you feel confident in your repayment strategy, reducing the stress this has caused.

How a Line of Credit Works — and When It's Smarter

A personal line of credit (PLOC) works similarly to a credit card. Unlike a personal loan, where you receive a lump sum of cash with a fixed interest rate, a PLOC provides a credit line that you can access whenever needed at a variable interest rate linked to the prime rate.

The attractive part of using a PLOC is that you only borrow what you need. This means you pay interest solely on the amount you borrow. As you repay your balance, you can continue borrowing up to your credit limit.

Payments can be quite different with a PLOC, which may be a drawback for some. Instead of fixed monthly payments, you’ll have a minimum monthly payment based on your outstanding balance. 

When a Line of Credit May Be the Better Option

A PLOC is a better choice than a personal loan when you need more flexibility. Instead of getting a lump sum of cash, you can draw on your available credit anytime and only pay interest on what you borrow. Some situations where a personal loan would make sense include:

• Freelancers with fluctuating income

• Ongoing home improvement projects

• To create an emergency buffer beyond your savings

• Situations where the final cost is uncertain

To fully understand when using a personal line of credit would make the most sense, consider this example:

You've been living in your home for a few years, and now you've decided to start making some upgrades over the next couple of years. Since you’re unsure of the total cost of these improvements, you want to avoid guessing how much you'll need and avoid paying interest unnecessarily. 

You decide that it would make more sense to have a line of credit because then you can pay for the work as it's completed and only pay interest on the amount you actually borrow.

However, before choosing a PLOC, it's important to be aware of a few things that could affect you.

• PLOC interest rates are variable and can fluctuate at any time.

• Your minimum payment can increase when you borrow additional funds and when interest rates rise. 

• Having easy access to cash can increase total borrowing.

How To Choose Between a Personal Loan and a Line of Credit

Choosing between a personal loan and a line of credit usually depends on three main factors: how much money you need, when you need it and how you want to pay it back. As we review each of these factors, the right choice will likely become clear. 

1. Start With The Type of Expense

The first thing you need to ask yourself is whether you need cash for a one-time expense or for something that will occur over time. Personal loans generally make sense when the expense is a fixed amount of money. This includes items like the following:

• Consolidating $10,000 in credit card debt

• Paying off an $8,000 medical bill

• Funding a wedding or major expense 

In situations like these, you need to borrow money once and then start paying off the loan.

But when the expense is ongoing or unknown, it might be best to use a personal line of credit. This could include any of the following:

• Home renovations carried out in stages

• Medical expenses that may extend beyond a single event

• Unpredictable emergency expenses

2. Decide If You Want a Structured or Flexible Repayment

You'll also need to ask yourself what type of repayment schedule is going to work best for you. With a personal loan, you'll know everything before you even receive any money. This includes the:

• Loan amount

• Interest rate

• Monthly payment

• Payoff date

This is ideal if you prefer predictability and a fixed payment that fits into your budget.

However, a PLOC offers more flexibility. You can borrow money anytime, up to your credit limit, and only pay interest on what you borrow. This flexibility can come with a cost though. Since PLOC interest rates are variable, they can increase at any time, making your monthly payments higher.

3. Consider How Much Cash You'll Actually Need 

If you only need money once, a personal loan can help you avoid borrowing more than necessary. But if you think you'll need cash over time, a PLOC can help you avoid taking out multiple loans.

4. Think About Your Personal Discipline

Something that most people don't think about is their own discipline. A personal loan will give you a fixed monthly payment, which provides a clear timeline for when you’ll be able to pay off your debt. This can be ideal for someone who might not trust themselves.

A PLOC offers more flexibility, but if you lack discipline, you might end up paying off your debt over a longer period, costing you more in interest than you expected.

The Bottom Line

Both a personal loan and a personal line of credit are options if you need money for specific expenses. However, it's important to understand both because one might be a better choice than the other. Begin by understanding if you’ll need cash once or multiple times. Personal loans are ideal for one-time needs, but PLOC is better for a recurring need for cash. 

Then you’ll want to consider the structure that suits you best. If you prefer a fixed monthly payment, opt for a personal loan. If you're comfortable with your monthly payments fluctuating, then consider a PLOC. 

Whichever product you choose, make sure to compare the rates. Select a few lenders and find out which will offer the lowest interest rates. Even a percentage point can have a big impact on how much your loan will cost. 

FAQs

Is a line of credit harder to qualify for than a personal loan?

Yes, a personal line of credit can be harder to qualify for, but it usually depends on the lender. The biggest reason is that a line of credit offers continuous access to funds, which can be be riskier for lenders.

Does a line of credit hurt your credit score more?

Having a line of credit won't hurt your credit score more, but how it’s structured can impact it differently. Since it’s a line of credit, borrowing the maximum could increase your credit utilization, which might negatively affect your credit score.

Can you pay off a personal loan early?

Yes, you can pay off a personal loan early, but you’ll want to understand if your loan has a prepayment penalty. 

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

The main differences between a personal line of credit and a credit card are how you access funds and the interest rates. Credit cards are primarily used for everyday purchases, while a line of credit functions more like a cash account. You can transfer the needed funds to your bank account and then write a check or transfer money online to cover expenses.

Sources:

• Citi®. "Personal Loan vs. Personal Line of Credit."

• Discover® Bank. "What's the Difference Between a Personal Line of Credit and Personal Loan?"