Personal Loans vs. Personal Lines of Credit: Which Is Best?

Personal loans and personal lines of credit are both helpful tools to cover large expenses. These financing options have similar benefits, like no collateral requirements and low rates for well-qualified borrowers, but deciding which is right for you comes down to how you prefer to receive and repay the funds.

Learn the similarities and differences between personal loans and personal lines of credit to determine which is right for your plans.

Personal loans and lines of credit: How they’re similar

Personal loans and personal lines of credit are typically unsecured, meaning you don’t have to pledge an asset as collateral in order to borrow. It also means the lender will rely mostly on your credit, income and existing debts to determine whether you qualify.

When you apply for either financing option, the lender will pull your credit report to examine your creditworthiness and how you handle existing debts. Applicants with good credit and low debt-to-income ratios have the best chances of qualifying and getting the lowest rates.

“The qualifications for both loan types are determined by an individual’s credit experience, employment stability and ability to repay the debt,” Jean Hopkins, director of consumer lending at WeStreet Credit Union in Tulsa, Oklahoma, said in an email interview.

Banks and credit unions offer personal loans and lines of credit, while online lenders offer personal loans, but usually not credit lines. Qualified applicants may be able to borrow up to $100,000 with either type of financing.

With both options, borrowers repay the debt, plus interest, over time. Missed payments are typically reported to credit bureaus after 30 days and can negatively impact your credit score.

Differences between personal loans and credit lines

Though qualifying for these two financial products can work similarly, they are two different types of credit. A personal loan is a type of installment loan, and a personal line of credit is a type of revolving credit.

With a personal loan, you receive funds as a lump sum and make payments in even installments over a fixed term, typically two to seven years.

Interest on personal loans is charged on the entire loan amount at a fixed rate.

Personal lines of credit are revolving credit, so you can borrow against your predetermined credit limit as needed and access more money as you make payments.

“When payments are applied to the principal balance of a line of credit, that amount is made available to borrow again,” Hopkins said.

A personal line of credit generally has a “draw” period and a “repayment” period, Katherine Fox, certified financial planner and founder of Sunnybranch Wealth in Portland, Oregon, said in an email.

The draw period is when you can access money from the credit line and make minimum monthly payments or interest-only payments, depending on the lender. This period typically lasts from two to five years. Once the draw period is over, you’ll enter the repayment period, when you can no longer withdraw money and must make payments until the end of the term, which can be up to 10 years.

Personal lines of credit have variable interest rates, and you only pay interest on the amount you draw. This means the monthly payment on a personal credit line can fluctuate.

Finally, the fees are different on personal loans and personal lines of credit. A personal loan may come with an origination fee, which the lender typically takes from the loan before sending you funds. A personal line of credit may have an annual maintenance fee as well as withdrawal fees every time you access funds.

When to consider a personal loan

A personal loan is a good idea when you know exactly how much you need to borrow and want a predictable repayment schedule. It can be ideal for:

• A large purchase.

• Debt consolidation.

• A one-time emergency.

“If you have an immediate need for a specific amount of cash, it makes more sense to get a personal loan,” Fox said. “You get all the cash you need at once and you will pay it back with a fixed interest rate.”

A personal loan may also be cheaper in the long term because you lock in an interest rate for the full loan term, Hopkins said. If the federal funds rate rises while you’re repaying a personal loan, for example, your rate and monthly payment won't increase.

Additionally, while interest rates are heavily based on the borrower’s credit and income, starting rates may be lower on personal loans than on personal credit lines.

Pros and cons of personal loans

Pros

• Fixed interest rates keep monthly payments predictable.

• Low interest rates for borrowers with good or excellent credit.

• No collateral needed.

Cons

• Bad credit may prevent you from qualifying.

• Possible origination fee.

• Can’t access additional funds after borrowing.

When to consider a personal line of credit

You might consider opening a personal line of credit if you need ongoing access to cash. This financing option may be ideal if you expect your expenses to fluctuate over time. Examples of expenses that may be right for a personal line of credit include:

• A home renovation project.

• A cross-country move.

• A wedding.

“If you are uncertain if you will need cash, uncertain about how much you will need and/or uncertain when you will need it, a personal line of credit may make more sense” than a personal loan, Fox said. “It gives you the flexibility to pull out more or less cash on your own timeline, rather than getting a single lump sum that you are responsible for repaying.”

Pros and cons of personal lines of credit

Pros

• Easy access to money as you need it.

• Only pay interest on what you borrow.

• Low interest rates for borrowers with good or excellent credit.

• No collateral needed.

Cons

• A variable interest rate means payments may be harder to budget for.

• Bad credit may prevent you from qualifying.

• Possible annual and withdrawal fees.

Borrowing alternatives

The best way to borrow money is to find the option that costs the least interest. Compare other financing options to choose the one that’s most affordable and fits your plans best. Here are some alternatives.

Zero-interest credit cards: If you have good or excellent credit, you may qualify for a credit card with a zero-interest introductory rate, usually for the first 15 to 21 months.

Buy now, pay later: A “buy now, pay later” plan can break the cost of a large purchase into four equal payments every two weeks, often at no interest. Longer payment plans may be available, but you’ll likely have to pay interest.

Home equity financing: A home equity loan and a home equity line of credit (HELOC) are types of secured financing that use a borrower’s home as collateral. Interest rates are usually lower compared to unsecured forms of borrowing. Lenders see home equity financing as less risky, because they can take ownership of your home if you default.

401(k) loan: Borrowing money from your retirement account comes with low interest rates, but your nest egg will miss out on potential growth and you could be forced to repay the loan in full if you leave your job.

Family loan: Borrowing from a loved one can be a quick way to access money with little to no interest and flexible repayment terms, but you could risk your relationship if the loan is not repaid as agreed. Be sure to draft and sign a payment agreement so both parties are on the same page about the repayment details.

» MORE: Personal loans vs. personal lines of credit for Canadian readers