- Personal loans and personal lines of credit each provide funds to borrowers without needing collateral.
- Personal loans provide upfront, lump-sum funding. They typically have fixed interest rates and require fixed monthly payments over a predetermined repayment period.
- Personal lines of credit allow funds to be borrowed when needed up to a credit limit. Interest rates are typically variable, and interest is paid only on the amount borrowed.
- Personal lines of credit provide a revolving credit option, allowing you to borrow, make payments, and borrow again as needed up to the credit limit.
When faced with a big expense or the need to manage debt, it’s helpful to understand your options. Personal loans and personal lines of credit are two popular choices that may help you get the funding you need without dipping into your nest egg.
Both are typically unsecured, meaning they don’t require collateral. However, to make an informed decision, it's important to understand both the similarities and differences between these lending options.
Line of Credit vs. Loan: Understanding the Basics
How funds are accessed and how you pay them back are the primary differences between a personal line of credit and a personal loan. Personal loans provide a one-time, lump-sum payment that you pay back with fixed monthly payments over a fixed period of time, while personal lines of credit offer flexibility in borrowing funds as needed up to the credit limit and paying outstanding balances in full or monthly. Here are a few other differences to consider.
How a Personal Line of Credit Works
A personal line of credit is a flexible way to borrow money. After applying, the lender reviews your credit history to determine the borrowing limit. Then, you’re free to borrow funds as needed at any time, up to the approved limit.[1] Often, lenders require minimum draw amounts, meaning borrowers have to borrow at least a certain amount of money each time funds are drawn.
Borrowers must make monthly payments, which typically vary each month based on the amount drawn, commonly referred to as the outstanding balance. Unlike a personal loan, personal lines of credit only charge interest on the amount withdrawn. For example, if you have a line of credit with a $10,000 credit limit and withdraw $2,000, interest is calculated on the $2,000 borrowed. As payments are made, the available credit increases, and you can take additional withdrawals up to the approved credit limit.
Interest rates on lines of credit are typically variable, fluctuating based on market conditions. The lender’s guidelines and your credit history may also affect the interest rate. In addition, some lenders charge an origination fee at the time the line of credit is established. Lines of credit may also incur additional expenses, such as annual charges or transaction fees, each time you draw funds.
How a Personal Loan Works
Unlike a line of credit, personal loans typically provide lump-sum funding upfront. Borrowers receive the entire loan amount at once and pay it back with interest over time. Personal loans, also called installment loans, require fixed payments on a predetermined repayment timeline, also known as the loan term.[2]
Personal loans typically have fixed interest rates that do not change throughout the repayment period. This predictability may make it easier to manage personal finances since you know exactly how much to budget for repayments each month.
Interest on personal loans begins accruing as soon as you receive the funds. In addition to the interest, personal loans typically include an origination fee, which the lender may deduct from the total loan amount before it's disbursed to you. Some lenders may also charge an early repayment fee, allowing them to recoup a portion of the interest they would lose if the loan is paid off early.
When comparing loans, it’s important to consider the annual percentage rate (APR). Since this calculation combines the interest rate with any fees and additional costs associated with the loan, it provides a more complete picture of the loan's full cost.
Advantages and Disadvantages
Both personal loans and personal lines of credit have unique benefits and limitations. Understanding what each option offers and potential pros and cons may help you choose the solution that best aligns with your financial goals.
Pros and Cons of Personal Loans
Pros:
- Fixed interest rates: The rate typically remains the same throughout the loan term, providing more predictability in financial planning.
- Structured repayment plan: Monthly payments stay the same throughout the loan term, which may help with monthly budgeting.
- Immediate access to funds: Borrowers receive the entire loan amount upfront, making personal loans useful for significant, one-time expenses.
Cons:
- Higher interest rates for lower credit scores: As with most loans, borrowers with a lower credit score may face higher rates, increasing the cost of borrowing.
- Origination fees: Personal loans often include origination fees, which may reduce the amount received.
- Early repayment penalties: Some loans charge penalties for paying them off early, potentially adding to the cost.
Pros and Cons of Lines of Credit
Pros:
- Flexibility: Allows you to draw funds as needed, up to the credit limit, making lines of credit ideal for covering ongoing expenses.
- Revolving credit: As you repay the amount borrowed, available credit increases, offering continuous access to funds up to the credit limit throughout the borrowing period.
- Interest charged only on amount borrowed: Borrowers do not pay interest on unused portion of the credit line, potentially reducing overall costs.
Cons:
- Variable interest rates: Interest rates for personal lines of credit can fluctuate, potentially increasing borrowing costs over time and making budgets less predictable.
- Potential fees: Lines of credit may incur annual fees, transaction fees, or other charges.
- Risk of overspending: Easy access to funds may lead to overspending, increasing debt burden.
How To Choose Between a Line of Credit vs. Loan
When choosing between a line of credit and a loan, consider your personal finances and the nature of the expenses. Here are a few scenarios in which each option might be more suitable.
When To Consider a Loan
A personal loan is often preferable for borrowers who have a clear, one-time financial need that requires a lump sum of money. Some common uses for personal loans include:
- Financing large expenses: For example, moving costs, vehicle repairs, funding a wedding, or paying for home renovation projects.
- Debt consolidation: Combining credit card debt and/or other high interest debts into a single, manageable payment with potentially lower interest.
- Medical bills: Covering larger unexpected medical costs that require prompt payment.
When To Consider a Line of Credit
A line of credit might be more suitable if your financial needs are ongoing or your future financial needs are not clear at the time of application. Common uses for lines of credit include:
- Ongoing home renovations: Since renovations often encounter unexpected expenses, having a flexible funding source allows homeowners to keep the project moving ahead without applying for additional funds.
- Emergency fund: A personal line of credit can act as a safety net for unexpected expenses, such as vehicle repairs, home repairs, or medical expenses.
- Seasonal or irregular expenses: Ideal for those who have seasonal or irregular expenses.
Some Final Thoughts
As you weigh the options, determine whether you need a lump sum upfront or access to credit on a recurring basis. In addition, consider your comfort with variable versus fixed repayment schedules and how each choice might affect your financial planning. Taking this approach may help you make a decision that meets immediate financial needs while also supporting long-term financial health.
No matter which solution you choose, PNC Bank is here to help. Explore lending options now or connect with our team for personalized advice.
