Personal Loan vs. Line of Credit: Here’s the Difference for Borrowers
When you need to borrow money, you have a few different options, including personal loans and lines of credit. A personal line of credit is an open-ended loan that lets you access money when you need it, similar to a credit card. When you use it, you incur interest on the amount you take out and are billed monthly for repayment. In contrast, with a personal loan, you borrow a lump sum for a set period and pay it back in installments.
Both of these options are unsecured loans, meaning they don’t require collateral. That makes them different from a secured loan, such as a car loan or a home equity line of credit, in which your property guarantees repayment. Here are more details on a personal loan versus a line of credit, so you can better decide which borrowing option is better for you.
Differences Between a Personal Loan and Line of Credit
If you’re choosing between these two ways to borrow money, knowing what makes them distinct from each other can help you decide. Here are the main differences between the two loan types:
- A personal loan is a lump sum; a personal line of credit is used as needed.
- You only pay interest on the money used in your personal credit line, but your bank might charge a fee for this use. You pay interest on the full amount of a personal loan.
- You pay a fixed amount each month on a personal loan, whereas you only pay on a personal line of credit when you use it, with a minimum monthly payment determined by what you used.
Learn: 7 Common Personal Loans — and Options for When You Can’t Qualify
How a Personal Line of Credit Works
With a personal line of credit, you’re approved for a set amount, similar to a credit limit. You tap into it as needed for any reason, from daily expenses to emergencies. A personal line of credit can also tide you over if you’re self-employed or work on commission and have gaps between paychecks.
Related: Apply for a Personal Loan Today
You access the funds by transferring money or writing a check against your line of credit. Depending on the account terms, the bank might charge you a fee to use the credit line. You’ll receive a monthly statement showing the minimum payment and interest charges. Like a credit card, you must pay at least the minimum. Some lenders might charge other fees, including prepayment penalties.
How to Qualify for a Personal Line of Credit
Like credit cards, personal credit lines are typically unsecured loans. Financial institutions often require you to maintain a checking or savings account to qualify for a line of credit. You also need a good credit history that shows you pay your bills on time and have a low debt-to-income ratio. Your credit score plays into the bank’s decision, but there’s no standard credit score requirement across all financial institutions.
For a personal line of credit, rates tend to be high, so you’ll save if you shop around for the best interest rate.
How Personal Loans Work
A personal loan provides you with a lump sum. It’s unsecured, which means a higher interest rate because there’s no property for the lender to seize if you default on the loan.
You can use your personal loan funds for any purpose, from home improvement to paying off a higher-interest credit card to taking a vacation. You’ll pay the loan off in installments. Read the terms and conditions to understand if any prepayment penalties or other fees apply.
Find Out: How to Get the Best Personal Loan Rates
How to Qualify for a Personal Loan
You need a good credit score and solid credit history to qualify for these unsecured loans. You might qualify for a personal loan even if you have had financial problems, but you’ll pay a higher interest rate and be limited in the borrowing amount. Even though these loans have higher interest rates for borrowers with bad credit, personal loans are a great way to rebuild credit history if you make all your payments on time.
Up Next: How Do Banks Decide My Personal Loan Eligibility?
