Personal Loan vs Line of Credit (Explained)

Whether you need money to remodel your home, pay an unexpected medical bill, or to start a business, you may be wondering whether to take out a personal loan or use your line of credit. The post will dive deep into the difference between a personal loan vs line of credit. We will explain the difference between the two below.

Personal Loan vs Line of Credit (Difference Explained)

A personal loan allows a person to borrow a fixed sum of money that must be repaid according to a fixed schedule. This is different from a line of credit where a person borrows money from a line of credit on an as-needed basis and has the ability to repay the money according to his or her own schedule, so long as the person makes the minimum monthly payment.

Summary of the Differences Between a Line of Credit vs Personal Loan

  1. Fund Dispersal – The way the funds are dispersed or paid out is different depending on whether you choose to borrow money from a line of credit vs personal loan. With a personal loan, you’re given a lump sum of money upfront. This is different from a line of credit, where you have access to a credit line that allows you to borrow money as you go.

  2. Repayment – When deciding whether to take out a personal loan vs line of credit, you should consider the method of repayment. For a personal loan, you will usually agree with the lender and the term of repayment, after you’ve agreed upon the terms, you will usually have a set monthly payment that you must make every month until the loan is paid off. The repayment of a line of credit is different in that you have no set monthly payment that you must make. The amount of money that you must repay depends on how much you’ve borrowed and the lender will most likely impose a minimum payment that you must make. The minimum payment is calculated based on the amount of money that you’ve borrowed. Usually, the minimum payment is set at 1% to 2% of the money that you have borrowed.

  3. Interest – Whether you choose to borrow money by taking out a personal loan or by obtaining a line of credit, you will have to pay interest on the money that you borrow. That said, borrowing money using a line of credit is typically significantly more expensive than borrowing money by taking out a personal loan. With a personal loan, the amount of interest that you’ll have to pay is almost always lower and it’s fixed, making your payments predictable and the same month over month. However, with a line of credit, your interest rate may change as you pay off your debt.

To illustrate the difference between a personal loan and a line of credit, see the following examples.

Personal Loan

If you head down to your local bank and take out a personal loan in the amount of $10,000, the bank will give you $10,000 in a lump sum. If you have good credit, you may qualify for a good interest rate, such as 4.95%. Let’s assume that the repayment term is 3 years. This will require you to make a $299 payment every month for 36 months.

On the other hand, with a line of credit, you have the option of borrowing money using your credit card’s line of credit or you can take out a home equity line of credit.

Credit Card Line of Credit

If you have a credit card with a $10,000 line of credit, you can borrow up to $10,000 using your credit card. By using your line of credit, you have the flexibility of making payments on your own schedule.

That said, you will have a minimum payment that must be paid every month to keep your account in good standing. The average minimum payment is 2% of the amount of money that you’ve borrowed. So, if you borrow $10,000, you should expect to make a minimum payment of at least $200.

However, if you’re only making the minimum payment, the amount of time that it will take you to pay off the money you’ve borrowed will be significantly longer than the amount of time it takes you to pay off a personal loan. This is so because the interest rate on personal loans is usually significantly lower than that of a credit card.

Having said that, borrowing money using your credit card’s line of credit is probably the most expensive option that you have to borrow money as the interest on credit card balance ranges from 14% to 20%, depending on the type of credit card that you have.

This is significantly more expensive than the

Home Equity Line of Credit (HELOC)

If you have a home, you may be able to access a home equity line of credit by using your home as collateral to borrow money. Unlike a personal loan where you’re given a lump sum of money, with a HELOC, you’re given a line of credit for a number of years that you can borrow money from on an as needed basis similar to a credit card.

The advantage that HELOC has over a credit card line of credit is that the interest rate on a HELOC is usually much lower than that of a credit card. This is so because with a HELOC you’re using your home as collateral. As of September 4th, the average interest rate on a HELOC is 4.7%, which is significantly lower than the interest rate on a credit card line of credit.

That said, unlike a credit card where the line of credit is usually unsecured, a HELOC is a secured line of credit with your home as collateral. So, if you default on your payments, your lender could foreclose on your home to recover some of its money, especially if you have a good amount of equity in your home. As such, you should be careful when using a HELOC because you could lose your home if you don’t make your payments on time.

Secured vs Unsecured

Whether you’re considering taking out a line of credit or personal loan to borrow money, you have the option of a secured personal loan vs unsecured personal loan, and you have the option of a secured line of credit vs unsecured line of credit.

Secured Personal Loan

Not all personal loans are the same. You have secured personal loans, which are loans where the borrower places collateral in return for being able to borrow money. If you default on a secured personal loan, the lender can legally take the collateral as repayment for the money that you borrowed but did not pay back. For example, if you took out a personal loan and you placed your home as collateral, the bank can foreclose on your home if you do not pay back the money that you borrowed.

Unsecured Personal Loan

An unsecured personal loan is different from a secured loan in that there is no collateral attached to the loan. The lender gives you the money based on your creditworthiness and promise to repay the money. Unsecured loans usually come with higher interest rates because the lender is taking a bigger risk since there is no collateral to reimburse the lender if the borrower defaults on the loan.

Secured Line of Credit

A secured line of credit is one where your credit line is secured against collateral that belongs to you. In the event that you fail to pay back the amount of money that you’ve borrowed, the lender will take the collateral as payment for the past due debt.

For example, if you take out a home equity line of credit, your line of credit is secured by your home as collateral. If you stop making payments on your line of credit, the lender could foreclose on your home to recoup the money that you borrowed and failed to pay back.

The same logic applies to a secured credit card. Secured credit cards work the same way regular unsecured credit cards work, the only difference is that you have to place a security deposit before the lender allows you to borrow money using it.

If you use a secured credit cards line of credit and fail to pay back the money that you borrowed on time, the card issuer can take the security deposit you placed with them to satisfy the unpaid debt.

Unsecured Line of Credit

An unsecured line of credit is a line of credit where the borrower does not place collateral to borrow money. The biggest example of an unsecured line of credit is a credit card. Most credit cards are unsecured, meaning the borrower is permitted to borrow money based on his creditworthiness and promise to repay the money he has borrowed. An unsecured line of credit is probably the most expensive way to borrow money because credit cards usually come with high-interest rates on the money that you borrow. The average APR on a credit card today is 15%, making it very expensive to borrow money using your credit card.

Should You Take Out a Personal Loan or Use a Line of Credit?

If you have a one-time purchase or bill that you need to pay, taking out a personal loan is more appropriate than obtaining a line of credit. Also, personal loans come with predictable monthly payments at low-interest rates. However, if you have on-going expenses, a line of credit is more suitable for you. So, when you don’t know how much you’re going to need, a line of credit is the better option. However, you should be aware of the fact that borrowing money using a line of credit may be more expensive, however, you will have more flexibility in paying back the money that you’ve borrowed.

Credit Score Planet Frequently Asked Questions

1. Which is better a personal loan or line of credit?

A personal loan is better for a person who knows the exact amount of money he needs because the funds are dispersed in a lump sum. If you do know the amount of money that you need, a personal loan is a better options because they comes with lower interest rates, meaning they’re a cheaper method of borrowing money.

2. What is the difference between a loan and a line of credit?

A loan allows you to take out a fixed amount of money in a lump sum, whereas with a line of credit, you will have a revolving line of credit that allows you to draw money on an ongoing basis. Loans typically have lower interest rates than lines of credit.

3. Do you need a good credit score for a line of credit?

Whether you’re applying for a line of credit or personal loan, you will have to have a good credit score, especially if the loan or line of credit is unsecured, meaning you’re not putting up collateral to borrow money.