Line of Credit vs Personal Loan: What to Know

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This Post: Line of Credit vs Personal Loan: What to Know

There may come a time when you need to borrow money to pay for a major expense item like a home renovation, a wedding, or medical bill, or you’re looking to consolidate debt. Personal loans and personal lines of credit are two tools that can help. But, while these two loan options serve similar purposes, there are some key differences between them.Read on to learn more about the definitions of and differences between these two types of personal financing, and when you would want to use a personal loan vs personal line of credit.

What Are Personal Loans?

A

personal loan

is a type of loan that gives you a set amount of money in one lump sum. You then repay that amount, plus interest, over time by making regular payments over the length of the loan, called the loan term. Personal loans usually have repayment terms of two to five years, but they can be as long as seven years.The

interest rate

, which is the fee lenders charge borrowers, is calculated as a percentage of the loan amount. With a personal loan, the interest rate is typically fixed, meaning it won’t change over the life of the loan, and your payments will always be the same. Personal loans are typically unsecured, which means you do not need to use an asset, like a car or home, as collateral. With a secured loan (like a mortgage, which uses your home as collateral), banks have the ability to seize the property to recoup any losses if you

fail to repay the loan

. Unlike a student loan or mortgage, lenders do not limit how you can use the money you borrow when you take out a personal loan. However, your lender may ask you what you plan to do with the loan on your application.  Personal loan amounts typically range between $1,000 and $100,000, depending on the lender and your creditworthiness. You can apply for a personal loan through a local bank, credit union, or online lender.Recommended:

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What Is a Personal Line of Credit?

A personal line of credit is a form of revolving credit that operates more like a credit card trương mục. With a personal line of credit, you can borrow money up to a certain spending limit, often $100,000 or more, as you need it. Interest starts to accrue as soon as you withdraw money, but you only pay interest on the amount you use. As you make payments on your line of credit, the credit available to you is replenished, and you can access it again.Unlike credit cards, personal lines of credit have a defined draw period, during which you can borrow money, and a repayment period, during which you repay the loan. Once the repayment period begins, you can’t withdraw any more money until you’ve fully repaid the loan. In some cases, you may need to make a balloon payment at the end of the draw period, in which you repay any remaining balance in one lump sum.Interest rates for personal lines of credit are variable, which means that they can change over time and, as a result, your payments can fluctuate. Personal lines of credit can be secured or unsecured, with the latter being more common. You can find personal lines of credit at banks, credit unions, and online lenders.Recommended:

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What’s the Difference Between Personal Loans and Personal Lines of Credit?

When deciding between a personal loan and a personal line of credit, there are some key differences to be aware of. 

Loan Amount

Personal loans require that you know exactly how much money you’ll need so that you can borrow the full amount in a lump sum from your lender. Personal lines of credit are more flexible in that you borrow on an as-needed basis up to your spending limit. Personal lines of credit also offer higher limits than personal loans, with some going as high as $500,000.

Repayment Terms

Monthly payments for personal loans are fixed. The amount you pay each month won’t change over the course of your repayment period, which can be easier to plan and budget for. Payments for a personal line of credit, on the other hand, can fluctuate widely from month to month because they are based on how much you owe and current interest rates on the trương mục.

Interest Rates

Personal loans typically have a fixed interest rate that’s set when you sign for the loan and doesn’t change over time. Personal lines of credit offer variable interest rates which are tied to the

prime rate

. If the prime rate increases, so will the interest rate on the line of credit. A variable rate can make it tricky to build your monthly payment into your budget. Personal lines of credit also tend to have higher interest rates than personal loans.

Fees

When you take out a personal loan, the lender may charge an origination fee, which can be anywhere from 1% to 8% of the loan amount. There may also be an application fee and an early pay-off (or prepayment) fee if you

pay off the loan before the end of its term

. Personal lines of credit typically don’t charge origination or prepayment fees, but they do often charge an annual fee, which can run $100 or more.Both types of loans will usually charge late payment fees.

Personal Loan vs Personal Line of Credit at a Glance

Typical Requirements for a Personal Line of Credit vs Personal Loan

When you apply for a personal loan or personal line of credit, lenders will look at your credit score and verify your income to determine whether to extend credit to you. In doing so, they are trying to assess the risk you may pose, or, in other words, whether you’ll be able to repay the loan on time. Minimum credit score requirements tend to be higher for personal lines of credit than for personal loans. For example, many lenders require a minimum credit score of 670 to approve a line of credit. It may be possible to

get approved for a personal loan

, on the other hand, with a score of 580. In both cases, however, higher scores can lead to a lower rate and more favorable terms. If your scores are lower than where they need to be, you may want to work on

improving your credit profile

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before you apply for a personal loan or line of credit.

Weighing your Financing Options

Here’s a look at when you might consider a personal loan vs. a personal line of credit.

When Might You Consider a Personal Loan?

Because you need to know how much money you’ll need up front when you take out a personal loan, good

uses for a personal loan

include consolidating debts and other one-time costs, such as a home or car repair, vacation, wedding, or medical expense. This type of loan doesn’t require collateral, typically offers a lower interest rate than a personal line of credit or credit card, and is easy to work into your budget since it has a fixed interest rate and monthly payments. 

When Might You Consider a Personal Line of Credit?

A line of credit is a flexible form of borrowing that can be useful when you aren’t sure exactly how much money you are going to need to borrow. For example, you could use a personal line of credit to fund an

ongoing home renovation project

. Lines of credit can also be useful for covering emergencies and if your income is variable, since it can help cover expenses during gaps in income.As with a credit card, you only pay interest on the portion of the credit you use. However, the interest rates for lines of credit are typically lower than they are for credit cards.

The Takeaway

Personal loans offer funds in one initial lump sum with relatively lower interest rates, while personal lines of credit give you the flexibility of accessing  funds as needed up to a predetermined limit. If you’re anticipating a large one-off purchase or expense and would like to have predictable monthly payments, a personal loan could be a good fit. If you’re curious about what rates and terms you might qualify for, Lantern by SoFi can help. With our online comparison tool, you can quickly

compare personal loan rates

to find the best deal. Photo credit: iStock/staticnak1983

The tips provided on this website are of a general nature and do not take into trương mục your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit (https://www.consumer.ftc.gov/topics/credit-and-loans)

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