They sound a lot alike and, at first glance, a personal loan and a personal line of credit might even seem interchangeable.
Both can help you pay for something—or some things. Both require you to pay back the money you borrow with interest. And no matter which one you choose, you’ll have to go through a credit check when you apply.
But there are some significant differences in how they work. Each has its strengths, depending on what you need the money for, so knowing a few basics about the difference between personal loans vs. personal lines of credit will help you find the best fit for your situation.
What is a Personal Line of Credit and How Does it Work?
A personal line of credit is a type of revolving credit, kind of like a credit card. Except that, in most cases, you’ll access the money by writing special checks provided by the lender instead of using plastic. Or you can request a transfer to your checking account online or by phone.
Also like a credit card account, you’ll have a credit limit, receive a monthly bill that requires at least a minimum payment, and pay interest.
Some types of personal lines of credit, such as HELOCs, may require paying annual fee. Others may require a fee each time you use the account.
Personal lines of credit are usually unsecured, although you may be able to put up some collateral to get a lower interest rate. (You’ve probably heard of a home equity line of credit, or HELOC, which is secured by the value of your home.)
Typically, a personal line of credit will be offered by a bank or credit union, and you might have to have a checking account with the institution that’s lending you the money.
If your line of credit is unsecured, the interest rate will probably be variable—which means it could go up or down while you’re making payments. But you’ll only be charged interest on the credit when you actually start using it , which could potentially save you money on interest in the long run.
So if you expect to have ongoing expenses, or if you have a big expense (like a wedding or home renovation) but don’t know what your final budget will be, this type of borrowing might be right for you.
A personal line of credit also may be the right fit if you need some flexibility with your borrowing. For example, self-employed workers who know they’ll be paid by a client, but aren’t sure exactly when, can tap into their line of credit to take care of expenses while they wait. They can pay that money back when they receive payment, and they won’t have to use high-interest credit cards or borrow from their retirement savings to make ends meet.
Of course, there’s a downside to that easy access to money. Since unsecured lines of credit are riskier for banks, it’s more difficult to qualify, and to get a good interest rate. Also, if you lack self-control and find it tough to stick to a budget, knowing your credit line is always there to back you up might make spending a bit too easy.
What is a Personal Loan and How Does it Work?
With a personal loan, you borrow a predetermined amount of money that comes to you in a lump sum, and if you opt for a fixed-rate loan, you’ll repay the loan in fixed payments over a prearranged period of time. (Or, if you have a variable-rate loan, you’d make monthly payments, but they may fluctuate as your interest rate changes in accordance with market rates.)
Because personal loans typically have lower interest rates than credit cards, they’re often used to pay off big expenses (home and car repairs, unexpected medical bills) or to consolidate other higher-interest debts (credit card bills) into one manageable (and probably lower) monthly payment.
A personal loan also could be a suitable choice for paying for a wedding, home renovation, or some other project. But it’s important that you feel confident about being able to repay the loan on time and in full.
If that kind of discipline is in your DNA, you might prefer the predictability of a personal loan over a personal line of credit.
Because you get all your money up front, if your interest rate is fixed, your payments will be the same every month—based on the entire amount of the loan, plus interest. (Again, if you have a variable-rate loan, your payments may fluctuate as your interest rate is influenced by current market rates.)
However, if you find you didn’t need the entire amount you borrowed or you can pay off the loan sooner than planned, you may be able to do so without a penalty—as long as that option is in your loan agreement.
You can get a secured or unsecured personal loan and, just like with a personal line of credit, that decision will affect the interest rate the lender offers. Of course, your credit standing, income, and other factors will be considered as well. You also may have a choice between a fixed or variable interest rate, so be sure you understand how that decision could affect your payments over the length of your loan.
Just like with personal lines of credit, personal loans may have their downsides. A personal loan has fixed payments—meaning that if you don’t pay it all off by a certain time, there are consequences. For instance, if your personal loan is secured, your collateral—such as your home—could be seized by the lender; if your personal loan is unsecured, you could be sued by the lender.
Also, since the interest rate you’d receive is dependent upon your credit, a poor credit score could mean a high interest rate. Your personal loan may also come with origination fees or prepayment penalty fees—all worth considering before you apply.
Other Factors to Consider
When you’re deciding whether to apply for a personal line of credit or a personal loan, it’s important to consider the effect borrowing money can have on your credit score. If you borrow money without a repayment plan in place and use it for a 4K TV or a smart watch, you could run into trouble no matter which borrowing option you go for. But they are looked at differently by the credit bureaus.
A personal line of credit is treated as revolving debt, which means it will factor into your credit utilization ratio —how much you owe compared with the amount of credit that’s available to you.
For a FICO® score or a score by VantageScore® , it is good practice to keep your total credit utilization rate below 30% . The closer you get to reaching the limit of your credit line, the more it could affect your credit score.
A personal loan is treated as installment debt , so it isn’t considered in your credit utilization ratio. In fact, if you pay off your revolving debt with a personal loan, it can lower your utilization ratio and could have a positive effect on your credit standing. A personal loan also can add some variety to your credit mix —something else that’s calculated into your credit score.
Before You Decide…
Before you decide to take out a line of credit or a personal loan, it’s wise to compare the costs among lenders. Look at the annual percentage rate (APR), if and how much that rate can change over time. You can also take into account any fees you might have to pay, including origination fees, annual fees, access fees, prepayment fees and late payment fees.
With a SoFi personal loan, you won’t pay any fees, and there are no hidden costs.
And as a SoFi member, you also might be eligible for special member benefits like unemployment protection (if you qualify) and career support. And you’ll have access to other financial services you may need in the future—from home loans to wealth management.
Deciding when and how to borrow money can be a tough decision. But once you check out the lending options available, find your fit, and are ready to go, you’ll want the application and approval process to be as painless as possible. Applying for a SoFi personal loan online is easy—you can get prequalified in just a few minutes.
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