Personal loan vs line of credit: Which is right for you?

Personal loans and personal lines of credit are two good options if you need a little extra help in realizing your dreams. However, the dilemma of personal loan vs credit card can present itself when the time comes to decide on the best solution for your needs.

Personal loans can be an especially good option if you’re paying for a large one-time expense, while personal lines of credit are generally better for ongoing borrowing needs. There are several other factors to consider when deciding which one is right for you. We’ll break down how personal loans and lines of credit work so you can be confident in choosing the right one for your family.

Understanding personal loans

If you want to borrow a large lump sum of cash and pay it back with monthly payments over time, a personal loan is better suited for you. These installment loans are disbursed in one large sum, typically as a deposit to your bank account or mailed out as a check. Personal loans feature fixed interest rates, which means your monthly payment will also stay the same until you pay off the loan.

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One of the reasons why personal loans are so popular is because they can be used for just about anything. However, most lenders prohibit you from using loan funds for gambling, investing, or post-secondary education. Some of the most common personal loan uses include:

• Moving
• Veterinary bills
• Debt consolidation
• Medical procedures
• Emergency expenses
• Home improvement and emergency repairs

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Consolidating credit card debt is one of the most popular uses of personal loans, with over half of borrowers using personal loans for this purpose in 2022, according to TransUnion. Personal loans typically charge lower interest rates than credit cards and come with shorter repayment periods, although you’ll typically need good credit in order to qualify for lower rates.

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It’s also a good idea to have a plan to keep your credit card balance low going forward. According to Experian, the average debt consolidation loan borrower pays off 57% of their credit card balances, but within 18 months their credit card balances have climbed back up again — only now the borrowers have a personal loan to pay, too.

Personal loans: pros and cons

Pros

• Fixed interest rates
• Quick funding timelines
• Fixed monthly payments
• Cheaper than revolving credit
• Less foreclosure risk if you default

Cons

• May charge origination fees
• Good credit required for the best rates
• More expensive than equity-based financing

Understanding personal lines of credit

Personal lines of credit are a type of revolving credit and operate more like credit cards. When you apply, the lender may approve you to borrow up to a certain credit limit. Indeed, some lenders even offer a card you can use to pay for purchases. You may also be able to submit a request over the phone or online to draw funds from your line of credit and have them deposited into your bank account.

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Personal lines of credit are commonly used for purposes like:

• Backup source of emergency funds
• Dealing with seasonal changes in income and financial vulnerability
• Overdraft protection on a checking account
• Paying for ongoing project costs like DIY home upgrades

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Personal lines of credit may be open-ended, like credit cards, with no set end date. It’s also common for personal lines of credit to be structured like home equity lines of credit (HELOCs), with a defined “draw phase” lasting several years where you can borrow money and make interest-only payments until the line of credit transfers over to a “repayment phase.” The line of credit essentially becomes a loan at that point. Once that happens, you won’t be able to borrow additional funds.

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Personal lines of credit generally come with variable interest rates, and since your payment scales to the amount you borrow, your monthly payment may also change frequently. If you pay extra on your line of credit, you can refresh your credit limit so you can borrow more money again in the future.

Personal lines of credit: pros and cons

Pros

• Variable interest rates
• Instant access to funds
• Less foreclosure risk if you default
• Interest-only payments during draw period
• No interest or payments unless you borrow funds

Cons

• Easier to overspend
• May charge more fees
• Doesn’t offer rewards or cash back
• Monthly payments change frequently
• Structure varies more among lenders
• Good credit required for the best rates
• More expensive than equity-based financing
• May have minimum draw requirements
• Can harm your credit score if you borrow a large amount

Key differences: personal loan vs line of credit

Let’s take a closer look at the differences between a line of credit vs personal loan:

Term length

Most personal loans are between three and five years in length, although some lenders offer personal loans as short as six months and as long as 10 years. Longer-term loans generally result in smaller monthly payments but higher overall interest costs.

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Personal lines of credit can be either open-ended with no set end date, or they may come with defined draw periods and repayment periods lasting five to 15 years each.

Interest rate structure

Personal loans typically charge fixed rates, and they’re generally lower than a line of credit. That keeps your payment amount predictable and steady. It also means you could be locked into an expensive loan if rates decrease, and vice versa: if rates increase, you’ll benefit from your lower-rate fixed-interest loan.

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Personal lines of credit generally feature higher rates that are variable. If rates decrease, you might pay less interest and make smaller monthly payments than with a fixed-rate loan. The flip side is also true — if rates go up, your monthly payment and interest costs could increase considerably, making it harder to fit into your budget. Most lenders have lifetime interest rate limits in place, however, and caps on periodic interest rate adjustments.

Credit score effects

You’ll generally see a small, temporary decline in your credit score whenever you apply for new credit, including personal loans and lines of credit. Making late payments on either type of debt can also cause a lot of damage to your credit score, while making on-time payments as required can cause your score to increase over time.

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If you use a personal loan to consolidate credit card debt, you’ll generally see a larger increase in your credit score very quickly. Personal lines of credit, on the other hand, can help increase your credit score if you don’t use much of your overall credit limit, including your credit cards. If you do, your credit score may decrease until you repay the debt.

Access to funds

Personal loan funds are paid out in one lump sum as a deposit into your bank account. Some lenders mail out checks, and local lenders may even offer cash directly.

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Personal lines of credit aren’t automatically paid to you unless your lender requires a minimum draw. Instead, you’ll need to contact your lender to request a draw, which can often be handled automatically online. Some lenders may offer a book of checks or a swipeable card that you can use. You’ll be able to draw funds as needed during a draw phase. Access to funds stops when you enter the repayment phase of the line of credit, however.

Personal loan vs personal line of credit: Which is right for you?

When a personal loan is a good idea

A personal loan is a good idea if you can put all of the loan funds to a specific use right away.

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Whether you’re consolidating debt, dealing with surprise emergencies, or paying for solar panels and other home upgrades, a personal loan is a good bet. You don’t need to spend all of your personal loan funds in one area, either. You can use a portion of the loan funds to consolidate debt and catch up on home repairs, for example.

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Personal loans are also a good option if you want smaller, more predictable than a personal line of credit offers. Because personal loans feature fixed rates with defined term lengths, it’s easier to plan for these payments in your budget.

When a personal line of credit is a good idea

A personal line of credit is a better choice if you want the option to borrow money repeatedly in the future, but you’re not sure exactly when you’ll need it.

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It’s also a good option to have in your back pocket in case you need fast access to money and don’t want to reapply for a loan each time. You can often get a personal loan within a matter of days, but requesting a draw from your personal line of credit may be instantaneous. This can offer peace of mind that you’re prepared for emergencies, although most financial experts recommend saving up a separate emergency fund as well.

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Keeping a personal line of credit open can also help your credit if you manage it well by making each payment on time and keeping your balance low relative to your credit limit. This works to lower your credit utilization ratio — the percent of available credit you’re using across all lines of credit, including credit cards — which in turn can help grow your credit score. You’ll also avoid a fresh hit to your credit score from applying for a new personal loan each time you need to borrow money.

Final thoughts

Choosing a personal line of credit vs a personal loan is a highly personal decision and depends on your needs, preferences, and qualifications. Regardless of which one you choose, it’s essential to make sure you can afford the monthly payments by consulting your budget before you apply for credit. When you're ready to get started, make sure you check your rates and options with at least three lenders so you can select the best financing offer.