What is a personal loan?

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A personal loan is money borrowed from a lender in a lump sum that is then paid back, with interest, in fixed installments each month. They’re great for helping you with large one-time expenses, such as tuition, a wedding or even a down payment on a new car.

You may find it easier to get a personal loan with poor credit compared to a personal line of credit. And unlike home equity or auto loans, personal loans are usually unsecured — they don’t require collateral, a piece of property you agree to surrender if you can’t pay — and can be used however you see fit.

Personal loans also have set payment periods, meaning there’s a clear end date for your debt. Longer payment periods might mean higher overall costs — you’ll end up paying more in interest — but they will lower your fixed monthly payments.

Having a clear-cut timeline on your loan is useful because it lets you plan ahead. You’ll also always know exactly how much you’re paying each month, so your debt won’t get out of control.

What is a personal line of credit?

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While personal loans are great when you know your exact costs, personal lines of credit (LOC) are better suited to uncertain, ongoing or revolving expenses.

With an LOC, you’re presented with a pool of available money, and you can pull as much or as little as you need, whenever you need it. You’ll only get charged interest on the money you actually borrow.

The interest rates are typically variable, so they’ll fluctuate with whatever the prime rate is.

Personal lines of credit are commonly unsecured — you don’t put up collateral — so the risk for the lender is higher. You’ll need a pretty good credit score to be approved for one, and they also have higher interest rates than personal loans.

Lines of credit have minimum monthly payments, but you can pay more if you’re able. When you pay off part of your balance, those funds become available to borrow again for the rest of the draw period.

That period, when you can access the cash, can be fairly short, lengthy or even open ended. It just depends on your lender.

Basically, an unsecured LOC functions like a credit card — but with a lower interest rate and higher borrowing ceiling.

Lenders also offer secured lines of credit. For example, a home equity line of credit (HELOC) functions a bit like a second mortgage. Your lender will probably give you access to a larger sum of money but will ask you to put up the value of your home as collateral.

What’s better: a loan or line of credit?

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Let’s look at some of the key features of the two options:

Loans vs. Lines of Credit
Loans Lines of Credit
Amount Up to $100,000 Up to $25,000 - $100,000.
Interest Usually fixed, on entire lump sum Usually variable, only on what you borrow
APR 5% to 36% 7% to 25%
Repayment Fixed monthly payments Minimum monthly payments
Timeline Can be as long as 7 years Can be open-ended

It’s important to understand these differences, but to pick the best option you also need to know your own situation.

Do you know exactly how much you’ll need and when? Check your credit score — is it high enough to get a personal line of credit? Can you afford the higher interest rates that usually come with a line of credit? Can you restrain yourself from dipping too deep?

Let's imagine you’re renovating your basement. You have contractors and engineers working for long periods of time. Pretty soon they discover problems with insulation and wiring. Your budget for the project is quickly getting eaten up by unforeseen costs. You start freaking out.

In this case, being able to draw on a reusable fund, offered by a line of credit, is ideal. If you only have a one-time endowment from your lender, like a personal loan, you’d have to find other sources of cash quickly and possibly get stuck with some ugly debts.

Different lenders and financial institutions have lots of different options and rates, so be sure to look around well before you need the money. One lender may give you better interest rates but a smaller pool to draw from, for example. You’ll also want to be on the lookout for fees: a lender might charge you a hefty “origination fee” to get a personal loan or charge an annual fee to keep a line of credit open.

Fiona is a handy website that will let you quickly compare rates from multiple lenders at once, with no hidden fees. You can borrow as little as $1,000 or as much as $100,000.

Whatever you decide, be sure to repay your debts promptly. Otherwise you could lose your collateral (if you have a secured loan), seriously damage your credit score and have a much harder time finding someone to loan you money in the future.

About the Author

Josh Wilson

Josh Wilson

Freelance Contributor

Josh is a freelance contributor to MoneyWise.

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