- 8 min read
- A personal line of credit can be an alternative to a personal loan or a credit card
- A personal line of credit may be more flexible than a loan and cheaper than a credit card
- It’s worth considering a personal line of credit when you have a series of different, or uncertain, expenses coming up
You may need to borrow money for a variety of purposes. When you borrow, you can save money by matching the way you borrow with the way you plan to use the money.
One of the most flexible ways to borrow money is a personal line of credit. A personal line of credit lets you borrow different amounts at different times. It may allow you to do this more cheaply than borrowing on a credit card, and in larger amounts, too.
Personal loans and personal lines of credit are both ways to borrow money for a variety of purposes. Either type of borrowing may be secured by collateral, though they usually are not. Unlike a mortgage or an auto loan that are used for a specific type of purchase, however, personal loans and lines of credit may be used for a variety of things.
What is a personal loan?
A personal loan is an amount that is borrowed, with the lending terms determined, in part, by the creditworthiness of the borrower. In other words, the bank will decide whether to lend you money, as well as on what terms the loan will be offered, based on your ability to repay.
Personal loans provide you with the full amount of the loan upfront. You are given a set period to repay that amount, plus interest.
With a personal loan, you start paying interest on the full amount borrowed right away. The interest rate may be fixed or variable; but in most cases, it will be fixed. With a fixed interest rate, a personal loan will usually have regular payments of the same amount due every month.
Most personal loans do not require collateral to secure the loan. This means they will typically charge higher interest rates than do loans with collateral. However, according to data from the Federal Reserve, the average personal loan has a lower interest rate than does the average credit card.
What is a line of credit?
A line of credit is an amount of money you can access when needed. This way, you can apply once but then access money at different times.
A line of credit will have a specified borrowing limit. You can borrow up to that limit, as needed. Any amount you repay will once again become available for you to borrow.
Lines of credit are broken down into two periods — the draw period and the repayment period:
- The draw period is the time during which you can access money from your line of credit.
- The repayment period is the time you have to repay what you owe at the end of the draw period.
While you don’t have to repay the amount you borrowed until the draw period is over, you will generally have to pay interest on that borrowed amount. If you also repay what you borrowed during the draw period, you will make that amount available to borrow again. Repaying what you borrowed sooner will also reduce the amount of interest you have to pay.
The interest rates on personal lines of credit are usually variable. Often, they are set at a certain amount over the U.S. bank prime rate, which changes over time.
Like personal loans, personal lines of credit generally do not require collateral. Whether you get approved therefore depends on how good your credit is. Your credit will also determine the terms you get, such as the interest rate, how much you can borrow, and the length of your draw and repayment periods.
How to compare between a personal loan and a personal line of credit
The sections below describe how key parts of personal loans and personal lines of credit work.
Amount you borrow
For both personal loans and personal lines of credit, the amount you borrow can range from a few hundred dollars to tens of thousands of dollars. The key difference is that with a personal loan, you borrow the full amount once. With a personal line of credit, however, you can take money out in different amounts throughout the draw period.
Interest rates on personal loans and lines of credit are fairly similar. Each rate is likely to be higher than the rate on a secured loan (like a mortgage), but lower than typical credit card rates.
Interest rates on personal loans are usually fixed, which means they are set at the time you borrow the money. But interest rates on personal lines of credit are variable, which means they depend on what the rate is when you actually access the money.
Monthly payments on a personal loan are typically set at the same amount over a specific repayment period.
Payments on a personal line of credit are more variable. Because when you take money out, as well as in what amounts can change, the amount you owe can vary with a personal line of credit. Also, you may have the option of paying just interest on what you owe during the draw period. You would then start paying back what you borrowed during the repayment period. Finally, the variable interest rates of a personal line of credit will also affect your monthly payments.
Both personal loans and lines of credit may require upfront fees, in the form of application and/or origination fees. The primary difference is that some personal lines of credit may also have ongoing fees. These can include:
- Maintenance fees: A set monthly or annual fee required for maintaining the line of credit
- Transaction fees: An amount of money charged each time you access money from your line of credit
Credit scores range from 300 to 850, with good credit scores typically being 670 or higher. Unsecured loans typically require good credit. This means your chances of getting a personal loan or line of credit are much better if your score is 670 or above.
You may be able to get a personal loan or line of credit with a lower credit score. However, you are likely to pay a much higher interest rate than a borrower with a better score.
How you get the money
This is one of the big distinctions between a personal loan and a personal line of credit. With a personal loan, you get the full amount upfront. Since you also start paying interest on that amount right away, it’s a good idea to be ready to use the money as soon as you get it.
In contrast, a personal line of credit allows you to get the money in different amounts and at different times.
Pros and Cons of a Personal Loan and a Personal Line of Credit
- Set monthly repayment amounts help you budget
- Fixed interest rates allow you to know what your borrowing costs will be from the start
Personal Line of Credit
- The ability to access money as needed can help you borrow efficiently for a variety of needs, at different times
- More flexible repayment terms may help you adjust to other demands on your budget
- Borrowing the full amount upfront means you start paying interest on that amount right away, whether you start using the money then or not
- If additional expenses come up, you may have to apply for a new loan to meet them
Personal Line of Credit
- Variable interest rates mean your borrowing expenses could increase if interest rates rise
- Ongoing maintenance or transaction fees may add to your borrowing costs
When to Take a Personal Loan vs. a Personal Line of Credit
Both personal loans and lines of credit can be useful methods of borrowing. The sections below summarize when it’s the right situation to consider each.
When to consider a personal line of credit
A personal line of credit is useful when you anticipate large, upcoming, expenses but don’t expect those expenses to arise all at once. A personal line of credit can also give you flexibility if you don’t know exactly how much those expenses will be.
In this way, a personal line of credit can be thought of as an alternative to using a credit card. Yet the former may be more cost-effective than a credit card, depending on the interest rate and fees you can get on a personal line of credit.
When you should consider a personal loan
A personal loan may be a good fit when you have a single, predictable, expense in the near future. A set borrowing amount, a fixed interest rate, and regular monthly payments make the borrowing costs on a personal loan more predictable.
How do I apply for a personal line of credit?
Many lenders will allow you to apply online. You will need to provide identifying information, like your name, address, and Social Security number. The lender is also likely to ask for personal financial information, like your income and the amount of your debts and regular expenses. Finally, you will have to authorize a credit check.
Is a personal loan or a personal line of credit cheaper?
It depends on how you use the loan. Most likely, if you have a single, one-time expense, a personal loan will be cheaper. That’s because personal loans don’t have the ongoing expenses of many credit lines. However, if you anticipate needing money at different times, a line of credit can help you avoid paying interest before you need to.
Which is harder to be approved for: a personal loan or a personal line of credit?
Because personal-loan terms are more clearly defined, it will generally be easier to get a personal loan than a personal line of credit.