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

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A line of credit is an amount of money you’re continually allowed to borrow at any time.

A loan is a lump sum of money you receive upfront and are required to pay back in installments.

This overview looks at the pros and cons of a personal loan and a line of credit, so that you can decide whether you should get a personal loan or a line of credit for your situation.

Key Differences Between a Line of Credit and a Loan

What Is a Line of Credit?

A line of credit is a “revolving” loan that effectively gives you access to a predetermined amount of the bank’s money. You can borrow it when you need, and you can let it sit and gather dust when you don’t.

Credit cards are a common example of a line of credit. If you’ve got a credit card with a $10,000 line of credit, you’re free to borrow up to $10,000 from the bank for your expenses. If you spend $1,000, your available credit — the amount you can borrow — will drop to $9,000. When you pay off your balance, your available credit will return to $10,000.

A line of credit is most often used for everyday purchases like grocery shopping, filling up the car, eating at restaurants, etc. It’s best for smaller purchases that you can quickly pay back, as the interest you’ll incur for carrying a balance is often nightmarishly high.

What Is a Loan?

A loan is also a way to borrow money from the bank — but instead of a revolving line that you can reuse, it’s a one-time lump sum of money that’s deposited into your bank account. You will then make monthly payments — with interest — to repay the bank for that money.

Loans are ideal for large purchases or emergency expenses.

Common uses include:

• Credit card debt consolidation
• Home renovations
• Higher education
• A new car
• Mortgages

Example: How a Loan Works

If you open a $10,000 loan, the bank will drop the money into your account. You can cash it out or use it however you please — as long as it’s lawful.

How Does a Line of Credit Work?

To open a line of credit, such as a credit card, you’ll do the following:

1. Submit an application with the bank or credit union, either online or in-branch.
2. You generally won’t know your exact terms, such as the APR or the size of your credit line, until you’re approved — though some financial institutions may preapprove you to give you a sneak peek of what you’ll get.
3. Once approved, you can begin spending your credit line.
4. In the case of a credit card, you’ll only be charged interest when you carry a balance month-to-month.
5. Pay your balance in full, and the money you borrow won’t have any fees at all — unless your card has an annual fee or you engage in activity that incurs a penalty, such as a cash advance.

How Does a Loan Work?

A loan works differently from a line of credit in that you’ll know exactly the amount of money you’re borrowing along with the interest rate. When you open the loan and receive your money, you’ll be put on a fixed monthly installment plan with a definite end date — though you can often pay the money back early penalty-free.

Another difference between line of credit and loan is that interest is inescapable with an installment loan — it’s baked into your monthly payment. Fortunately, loans tend to have considerably lower interest rates than lines of credit, especially for those with excellent credit scores.

Pros and Cons of Each Option 

Line of Credit Pros

• Borrow money whenever you like
• Great for building credit
• Only pay interest on borrowed money that you carry month-to-month

Line of Credit Cons

• Interest rates are often through the roof
• Lines of credit, like credit cards, sometimes come with annual fees
• The ability to borrow money for everyday expenses may cause you to overspend

Pros of Getting a Loan

• Predictable repayment terms
• Often comparatively low interest rates
• Potentially higher borrowing limit than a line of credit

Cons to Getting a Loan

• Less repayment flexibility — you’ll owe the same amount each month
• Repayment terms tend to be much shorter than lines of credit
• Occasional origination fees when opening an account

How To Choose the Right Option for You

How To Apply for a Line of Credit or Loan

Most mainstream banks and credit unions offer both lines of credit and loans. You can apply online or in-branch.

1. Consider Your Credit Score

Before you get a personal loan or a line of credit, if your score is below 670 — which is FICO’s definition of “good” — you’ll be limited in the products you can open. Make sure you know the credit score requirements of the loan or credit line you’re eyeing. It’s recommended to have a credit score of at least 700 before applying for either.

2. Gather Your Documents

For something like a credit card, you’ll typically need to enter simple information like your Social Security number, household income and physical address.

For loans — particularly if you’re applying for a larger amount — you may be asked to provide pay stubs and ID.

3. Your Loan Approval

If there are no snags during the application process, you could be approved within seconds of submitting your application. Otherwise, your application may show as “pending,” meaning the bank needs more information from you before making a decision.

Line of Credit vs. Loan: Your Next Steps

A line of credit and a loan offer a solution for different needs — one offers an ongoing credit line you can use and the other provides funds in a lump sum. Consider how each would apply to your situation and choose the one that helps you stay in command of your finances and reach your goals.

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