Line of Credit vs. Personal Loan Explained

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Reviewed byAlvin Yam, CFP
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Reviewed byAlvin Yam, CFP
Edited byCasie McCoskey
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Updated: May 8, 2024

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Credit allows you to borrow money, providing the flexibility to spend now and repay later. Lines of credit and personal loans are two popular financing options, but each functions differently. By understanding how they work and weighing their benefits and drawbacks, you can determine which suits you best in the short and long term.

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What Is a Line of Credit?

A line of credit allows you to access a predetermined amount of funds you can use whenever needed. This includes uses like managing cash flow, consolidating debt, funding home improvement projects and covering unexpected expenses. Here are some of the main features of a line of credit:

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Types of Lines of Credit

There are three main types of lines of credit, each designed to serve different financial needs and situations:

Personal Line of Credit: This type of credit is ideal for individuals needing flexible access to funds for personal use, such as covering unexpected expenses or financing large purchases. A personal line of credit is also suited for those with a stable income who can manage variable interest rates.

Business Line of Credit: Tailored for businesses, a business line of credit provides a flexible funding solution to manage cash flow, purchase inventory or finance other short-term operational needs. It is most beneficial for business owners who face irregular income cycles and need ready access to capital.

Home Equity Line of Credit (HELOC): Secured by the equity in your home, a HELOC typically offers lower interest rates and larger credit limits. It is an excellent choice for homeowners planning significant home improvements or needing substantial funds for major expenses.

Pros and Cons of Lines of Credit

Before getting a line of credit, understand its pros and cons to ensure you can leverage its flexibility wisely while being mindful of the financial risks involved.

Pros
Cons

Immediate access to funds: ​​You can draw funds as needed, offering flexibility during financial emergencies or opportunities.

Variable interest rates: Interest rates can fluctuate, which might increase borrowing costs unexpectedly.

Pay interest only on the amount you use: Interest is only charged on the amount drawn, not the total credit limit, reducing unnecessary costs.

Risk of overspending: Easy access to funds can lead to impulsive spending and debt accumulation.

Reusable credit: As you repay the borrowed amount, the credit becomes available again without needing to reapply.

Potential fees: Some lines of credit have annual fees or charges for unused lines, which can increase the cost.

Flexible repayment options: Most lines of credit offer flexible repayment terms, allowing you to manage payments according to your financial situation.

Higher rates compared to some loans: Interest rates on lines of credit may be higher than those on some secured loans, such as mortgages.

Potential for high credit limits: Depending on your creditworthiness, you can secure a substantial amount of credit, which is helpful for significant expenses like home renovations.

Impact on credit score: Mismanagement can negatively affect your credit score, impacting future borrowing ability.

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WHEN TO GET A LINE OF CREDIT

Consider getting a line of credit if:

  • You have short-term, flexible funding needs.
  • You are managing ongoing projects with variable costs.
  • You are disciplined with your credit usage.
  • You don’t need the full loan amount upfront.
  • Your other savings are unavailable for emergency expenses.
  • You want the flexibility to borrow funds as needed rather than taking out a lump sum loan.

What Is a Personal Loan?

A personal loan is money borrowed from a bank or lender that you repay in regular installments along with interest. It's commonly used for consolidating debt, financing major purchases or covering unexpected expenses. Here are some of the main features of a personal loan:

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Types of Personal Loans

There are several types of personal loans, each designed to meet different financial needs and circumstances:

Unsecured Personal Loan: This loan doesn't require collateral. It's ideal for borrowers with solid credit histories who need funds for general purposes like home improvements or personal expenses.

Secured Personal Loan: Secured loans require collateral, such as a car or savings account, which the lender can claim if the loan isn't repaid. This type suits those who may not qualify for an unsecured loan and are comfortable with risking collateral for lower interest rates.

Debt Consolidation Loan: This loan simplifies your payments and can help reduce the total interest paid over time by combining multiple debts into a single loan with a lower interest rate. It's best for individuals looking to manage and pay down their existing debts more effectively.

Co-Signed Loan: A co-signed loan involves a guarantor who agrees to repay the loan if the primary borrower fails to do so. This is a valuable option for borrowers with poor or limited credit history who can leverage a co-signer's credit strength to receive better loan terms.

Pros and Cons of Personal Loans

Before deciding on a personal loan, weigh its pros and cons so you can capitalize on its benefits while being prepared for any drawbacks.

Pros
Cons

Predictable repayment schedule: Fixed monthly payments make it easier to budget for your financial future.

Higher rates for poor credit: Borrowers with poor credit may face higher interest rates, increasing the cost of borrowing.

No collateral for unsecured loans: Unsecured personal loans do not require collateral, reducing risk to personal assets.

Origination fees: Some personal loans come with origination fees, which can add to the overall cost of the loan.

Quick funding: Once approved, funds are typically disbursed quickly, which is ideal for urgent financial needs.

Potential for debt accumulation: Easy access to funds can lead to borrowing more than needed, increasing overall debt.

Lower interest rates than credit cards: Interest rates for personal loans are often lower than those for credit cards, making them a cost-effective borrowing option.

Prepayment penalties: Some lenders charge penalties for early loan repayment, limiting flexibility in managing debt.

Can improve credit score: Consistent repayment of a personal loan can contribute to improving your credit score.

Strict eligibility criteria: High credit score and income requirements can make qualification difficult for some potential borrowers.

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WHEN TO GET A PERSONAL LOAN

Consider getting a personal loan if:

  • You need to cover a one-time expense.
  • You have high-interest debts you want to consolidate.
  • You prefer a fixed repayment plan.
  • You want a clear end date for debt.
  • You want to finance a planned large purchase.
  • You have a good credit score and want more favorable interest rates than credit cards or other forms of financing.

Line of Credit vs. Personal Loan

Choosing between a line of credit and a personal loan depends on your specific financial needs and repayment strategy. Lines of credit offer flexible access to funds up to a certain limit, allowing you to borrow as needed and pay interest only on the amount used, whereas personal loans provide a lump sum of money upfront with fixed repayment terms and interest rates.

Comparison Areas
Lines of Credit
Personal Loans

Type of Credit

Revolving

Installment

Loan Limits

Typically higher

Typically lower

Type of Interest Rate

Often variable

Usually fixed

Fees

Annual or transaction fees

Origination or prepayment fees

Credit Score Requirements

Varied, more flexible

Good to excellent for better terms

FAQ About Lines of Credit vs. Personal Loans

We compiled answers to some of the most frequently asked questions about lines of credit and personal loans to clarify key differences and help you determine which financial option best suits your needs.

What is the main difference between a line of credit and a personal loan?
Which typically has higher interest rates: personal loans or lines of credit?
How do repayments work on a line of credit compared to a personal loan?
Is it easier to get approved for a personal loan or a line of credit?
What are the usual fees associated with lines of credit and personal loans?
How should you decide between a line of credit and a personal loan?
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The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.

Editorial Disclosure: Opinions, reviews, analyses and recommendations are the author’s alone and have not been reviewed, endorsed or approved by any bank, lender or other entity. Learn more about our editorial policies and expert editorial team.