Personal Loan Vs. Line Of Credit: Which Is Better For Your Wallet?

by Zina Kumok

Forbes Advisor

Tuesday May 4, 2021

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Stock image  (Source:Getty Images)

When comparing two different products, you may just want someone to tell you what the best option is so you can buy it and get on with your life. However, when it comes to debt products, like personal loans vs. lines of credit, the best choice varies per person. That's why you need to understand the benefits and drawbacks of each option, so you can choose wisely.

If you're deciding between a personal loan and line of credit, we've got you covered. Here's what you need to know about each.


What Is a Personal Loan?

A personal loan is a financing method you can use for a variety of expenses, like remodeling your house, paying for a wedding or consolidating high-interest credit cards. They're usually unsecured, which means there is no collateral backing the loan.

The best personal loans typically have limits between $1,000 and $100,000, depending on the lender and your creditworthiness. You'll receive your funding as a lump-sum amount and repay it through fixed monthly installments, typically for two to seven years.

When to Choose a Personal Loan

The various types of personal loans are commonly used to cover expenses like emergencies, unexpected bills, home improvement projects, auto repairs and even debt consolidation. You should get a personal loan when you're certain of the amount you'll need to borrow.

For example, if you know you need to borrow $20,000 for a wedding, then choose a $20,000 personal loan. If you're not sure how much you'll need and have a ballpark number, a line of credit may make more sense.


What Is a Line of Credit?

A personal line of credit is more similar to a credit card than a personal loan. When you apply for a line of credit, the lender approves you for a certain amount, typically up to $100,000 with some lenders offering up to $500,000. Instead of receiving the amount as a lump sum, you can draw up to that amount on an as-needed basis. You only pay interest on the amount you borrow, and you'll repay your balance through fixed monthly payments.

When to Choose a Line of Credit

A line of credit is a solid choice if you want more wiggle room and a rainy day fund to pay for occasional expenses. Common uses include emergency expenses, long-term projects, education expenses, cash flow management and debt consolidation.

Because you'll receive a limit rather than a lump sum of money, you can use as much or as little of your limit as you need. For example, if you open a line of credit with a $30,000 limit, you can utilize all $30,000 or only a portion of it.


Personal Loan vs. Line of Credit: Key Differences

Loan Limits

Limits on unsecured lines of credit are higher than on personal loans. While some banks offer limits up to $100,000, you may find some lines of credit that extend up to $500,000. The maximum amount available on a personal loan is usually between $50,000 and $100,000.

Interest Rates

Interest rates on personal loans are usually fixed, ranging from 3% to 36%. Rates are determined based on your creditworthiness, which means if you have good credit and stable employment, you can land a more favorable rate. However, if your score is damaged, expect to receive a rate at the higher end of the range.

Conversely, a line of credit usually has a variable interest rate, which fluctuates based on the prime rate. If the prime rate increases, so will the interest rate on the line of credit. Borrowers can expect rates of at least 10%.

Fees

Lenders may charge an origination fee when you take out a personal loan, usually between 1% and 8%. Try to find a lender with the lowest origination fee, or none if possible.

An unsecured line of credit, on the other hand, may include an annual fee during the draw period. These fees are usually $100 or more. Some lenders will waive the fee for the first year.

Both financing methods typically charge a late payment fee.

Minimum Credit Score Requirements

Lenders often have higher credit score requirements for lines of credit compared to personal loans. For example, borrowers should aim to have a minimum credit score of 670 when applying for a line of credit. However, there are personal loans available that only require scores of at least 580. Keep in mind: A higher credit score can land you more favorable terms.

Term Lengths

Most personal loans have terms between two and seven years, and repayment begins once the lender disburses the funds.

A line of credit, on the other hand, has two separate terms: the draw period and the repayment period. During the draw period, which is usually between five and 10 years, borrowers can access the line of credit up to the limit and are required to make minimum payments.

When the draw period ends, the repayment period begins. During this time, which varies based on the lender, borrowers will not be able to withdraw money from the line of credit and must pay off the outstanding loan principal and accrued interest by a fixed date established in the loan agreement.

Repayment

When you initiate a personal loan, repayment begins immediately and lasts until you repay the loan in full. With a line of credit, however, you'll make minimum payments during the draw period and repay the remaining balance (including interest) during the repayment period. If you haven't drawn any funds, you won't have any payments.


Pros & Cons of Personal Loans

Pros & Cons of a Line of Credit

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