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Personal Loans vs. Personal Lines of Credit

People confuse personal loans and lines of credit. Here’s what you should know about the differences, including when one is better than the other.

September 28, 2021

True or false? Personal loans and personal lines of credit are the same thing. 

While both types of debt can fund a wide range of purchases in an even wider price range, they are two different solutions to a financial difficulty. It’s easy to confuse the two, however; their structures are fundamentally different.

Before you apply for a personal loan or personal line of credit, here's what you need to understand about them. Read on to learn how they work, how they differ and how to determine the best choice for you.

What is a personal loan?

A personal loan is a standard installment loan. Approved borrowers receive a lump sum that they can use however they like. Then, they’llpay the loan amount back plus interest in flat monthly installments over a predetermined term.

Personal loans function virtually identically to auto loans, student loans and mortgages. However, you can use the funds for more types of expenses, such as debt consolidation, emergencies or home improvements. Personal loans can be for as little as $1,000 or as much as $100,000 and are typically unsecured.

Pros and cons of personal loans

Like any other credit account, personal loans are a tool. They work better in some situations than others, and you have to use them correctly to see a benefit. Some of the primary advantages of personal loans are:

  • Flexibility: Personal loans often have high borrowing limits, and you can generally spend the proceeds on whatever you want. Your lender may have an exception or two, such as education expenses.

  • No security deposit: Personal loans are usually unsecured, which means borrowers don’t have to put up any collateral to qualify.

These two traits make personal loans useful in a wide variety of situations. However, they’re not without their drawbacks. For example, personal loans have:

  • Higher fixed payments: With a personal loan, you have a deadline to pay off your debt. That means you don’t have the luxury of cutting back to a minimum monthly payment in months with less discretionary income.

  • Potentially high interest rates: Personal loans typically cost anywhere from 6% to 36% APR, with the national average for outstanding accounts hovering around 9.41%.

Ultimately, if you can qualify for a personal loan and keep your interest rate down, you’ll get the most out of it. Meanwhile, people with lower credit scores may get stuck with an unaffordable payment or fail to qualify for a personal loan altogether.

What is a line of credit?

A line of credit is a form of revolving credit similar to a credit card. When a lender approves a line of credit, they’ll also assign a credit limit, which is the most that can be withdrawn at any time.

Then, you can then make purchases with the line and pay the amounts back in installments, much like you would with a credit card. Lines of credit can be secured (like home-equity lines of credit) or unsecured (like personal lines of credit).

Line of credit pros and cons

A personal line of credit is a convenient form of debt for people who can get them. They have some attractive advantages, including:

  • Reusability: All things being equal, revolving credit is generally better for borrowers than installment debt. You can tap into revolving accounts multiple times whenever you need to, while installment debt is by definition a one-time deal.

  • Affordability: Personal lines of credit tend to have lower interest rates than credit cards and let borrowers make smaller payments than personal loans.

Of course, every form of debt has its downsides, and personal lines of credit are no exception. Make sure you watch out for the following:

  • High qualification requirements: Borrowers can have more difficulty qualifying for a personal line of credit than they would a secured loan like an auto loan. They're also generally less accessible than credit cards and don't make good starter accounts.

  • No grace period: Unlike credit cards, they don't have a grace period, which means interest will begin accruing as soon as you draw on the line.

  • Variable interest rates: Lines of credit often have variable interest rates, which means there’s always the risk your rate could go up while you hold the account.

You might use a personal line of credit to fund a purchase that you want to pay back at a more relaxed pace, especially during a time with low interest rates. It probably wouldn’t be the best idea if you have a lower credit score or expect rates to increase soon.

Personal loan vs. line of credit: which one should you choose?

The primary difference between a line of credit and a loan is structures Personal loans are installment accounts and lines of credit are a form of revolving debt.

That would make personal lines of credit slightly superior to personal loans since you can reuse the funds if you want. However, in practice, other trends and extenuating circumstances can make the decision more complicated.

For example, personal lines of credit may have lower interest rates than personal loans, but that comes at the cost of slightly greater barriers to entry and no grace period. 

Ultimately, whether you should apply for a personal loan or a line of credit depends on three factors: 

  • Creditworthiness 

  • Available offers

  • Borrower needs

For example, say you manage to qualify for two debt accounts. The first is a 3-year personal loan for $5,000 at 7% APR. The second is a personal line of credit for $2,500 at 4% APR.

Which one you’d choose would depend on what you need. If you're looking to finance an improvement to your house that costs $4,000, you might have to pick the personal loan to cover the expense or delay the project.

On the other hand, if your goal is to consolidate $2,000 of credit card debt that you have spread over three credit cards, you could take the personal line of credit for its cheaper interest rate and reusability.

Ultimately, the choice between line or credit or a personal loan is personal. It will depend on the needs of the borrower first and foremost. 

If you’re thinking about consolidating your credit card debt, consider Tally's​​ lower-interest line of credit. Tally’s repayment tool consolidates your credit card debt into a single monthly payment, helping you get out of debt efficiently. 

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.