Line of credit vs. personal loan: How are they different?

If you need access to cash, either a personal loan or a line of credit could be an option. However, there are some significant differences in their availability, function and purpose. Plus, both come with benefits and drawbacks to keep in mind.

As you compare a line of credit vs. a personal loan, here are the main features to know about and how to choose which one will be the best fit for you.

What is a personal line of credit?

A personal line of credit is a revolving line of credit that functions similarly to a credit card — though it operates a little differently. You’ll have a credit line that you can draw from up to your preset limit, and you’ll pay back only what you borrow. To access your funds, you’ll typically need to request a transfer from your checking account or write a check.

Interest rates

Personal line of credit interest rates are usually variable, which means that both your rate and monthly payment can fluctuate over time according to market conditions. There are also some lenders that offer fixed-rate lines of credit where the rate won’t ever change.

Note, however, that instead of paying interest on the total line of credit, you’ll only be charged interest on the amount you actually borrow.

Loan amounts

Depending on where you look, you might be able to get a line of credit anywhere from $1,000 to $350,000. 

Repayment terms

Personal lines of credit have two periods: a draw period and a repayment period. During your draw period, you can withdraw money from your credit line as needed. You usually need to make interest-only payments during this time, but you can choose to pay down the principal, which frees up your available credit for re-borrowing. The draw period will vary depending on the lender but can last up to a few years.

Once that period ends, the repayment period begins, during which you’ll make full monthly payments. This term can last up to 13 years in some cases.

Common uses

There are many different ways to use a personal line of credit, some of which can make it a better fit than a personal loan. That said, you can use line of credit proceeds for just about anything you want.

For example, let’s say you want funds to consolidate debt, renovate your home or cover another major expense. However, you don’t want to start making full monthly payments immediately. With a line of credit, you can access the money you need and make interest-only payments during the draw period. This can free up some cash for other expenses and financial goals.

You can also use a line of credit in situations where either you want ongoing access to credit (such as for recurring expenses) or aren’t entirely sure how much money you need. Remember, you only have to pay interest on what you actually borrow, so a line of credit could save you some money compared to a large personal loan.

Pros

• Flexibility: During the draw period, you can withdraw money as needed, and you only need to pay the interest that accrues. This can give you some flexibility with the use of funds and your budget.
• Can be less expensive: Because you’re only paying interest on what you borrow, you might end up paying less interest compared to a personal loan, even if interest rates go up. Additionally, if rates drop, your variable interest rate can also go down.
• Longer repayment periods: Depending on which lender you choose and the size of your line of credit, you might have more time to pay off your debt once the repayment period begins compared to a personal loan.

Cons

• Fluctuating rates: Most personal lines of credit come with variable interest rates. This means you’re taking the risk that interest rates could go up. If rates rise, so do your monthly payments, which can put a strain on your budget.
• Can come with fees: In addition to interest, the lender might charge an annual or even a monthly fee, a draw fee or an upfront origination fee. These can all add to your borrowing costs.
• Less accessible: Personal lines of credit are generally less common than personal loans, so you might have fewer options to choose from. What’s more, lenders typically require good credit to get approved, so you might be out of luck if your credit is fair or poor. In general, a good credit score is considered to be a score of 670 or higher.

What is a personal loan?

A personal loan is an installment loan that provides a lump-sum disbursement upon approval. You’ll then pay this back in monthly installments over a fixed repayment period. 

Interest rates

Personal loan interest rates are typically fixed, so you know what your rate and monthly payment will be for the life of the loan from the very beginning. Because you receive the full amount upfront, interest accrues on the entire balance while you’re paying the loan off. 

Loan amounts

Depending on the lender, you might be able to get a personal loan anywhere from $300 to $100,000. 

Repayment terms

Personal loans don’t offer draw periods like personal lines of credit. Once your loan is disbursed, you’ll start making full monthly payments within a month or two. 

Repayment terms can range anywhere from one to seven years with major lenders. However, some lenders offer shorter or longer terms, depending on the purpose of the loan. For example, you could have up to 12 years to repay a LightStream loan used to make home improvements.

Common uses

A personal loan can be used for almost any purpose. For example, you could take out a personal loan to consolidate debt, pay for a wedding or cover emergency expenses.

You might consider a personal loan to cover expenses if you know exactly how much you need to borrow, want all of the funds upfront and prefer stable, predictable monthly payments.

Pros

• Fixed interest rates: A fixed interest rate won’t ever change, which can provide more certainty for your budget.
• Less complicated: You’ll get all of your money upfront, so you don’t have to worry about making draws every time you need cash.
• Wide availability: Personal loans are offered by a wide range of lenders, including online lenders as well as traditional banks and credit unions.

Cons

• Can be more expensive: You’ll pay interest on the full loan amount from the start, which could result in more interest charges compared to a personal line of credit. This is particularly true if you borrow more than you need. You also won’t be able to make interest-only payments with a personal loan, so it’s critical to make sure you can afford the monthly payments before you accept an offer.
• Stringent requirements: Most personal loan lenders require good to excellent credit, which can make it hard to qualify if you have poor or fair credit. While some lenders offer personal loans for bad credit, these can come with higher interest rates and more fees compared to good credit loans.
• Might come with fees: Some personal loan lenders charge an upfront origination fee, which can be costly and reduce how much you actually receive. Lenders might also assess additional fees, such as for late or returned payments.

Line of credit vs. personal loan

As you compare a personal loan vs. line of credit for your financing needs, here’s a quick summary of the differences to keep in mind:

FEATURE	LINE OF CREDIT	PERSONAL LOAN
Interest rates	% to 25%	6% to 36%
Loan amounts	$1,000 to $350,000	$500 – $100,000
Repayment terms (years)	5 to 10	1 to 7 (up to 15 for some loan purposes)
Common fees	Origination fee Annual or monthly fee Draw fee	Origination fee
Credit score requirements	Typically good to excellent credit	Typically good to excellent credit (bad credit loans available with higher rates)
Funding method	Bank transfer Cash withdrawal Paper check	Bank transfer Paper check Direct payment to creditors (for debt consolidation)

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When to choose a line of credit vs. a personal loan

Depending on your situation, one of the two options might be a better fit than the other. For instance, a line of credit could be a good choice if:

• You don’t know exactly how much you need to borrow.
• You want ongoing access to funds through a revolving credit line.
• You want the flexibility of interest-only payments.
• You want to be able to borrow money on an as-needed basis.
• You’re not concerned about the potential risks of a variable interest rate, and you can afford to make higher payments if your rate rises.

On the flip side, a personal loan might be a better fit if:

• You know exactly how much you need to borrow.
• You don’t require ongoing access to financing.
• You prefer a fixed interest rate and predictable monthly payments.
• You want to minimize potential fees.
• You can afford full monthly payments.

As with any other financial decision, take your time to research and compare your options to determine which is better for you. “Understanding the end goal of how and when you want to pay off each of these loans should impact your decision on which to move forward with,” says Cameron Smith, vice president of lending at Neighborhood Credit Union.