Personal loan vs line of credit for debt consolidation

Getty Images

We want to help you make more informed decisions. Some links on this page — clearly marked — may take you to a partner website and may result in us earning a referral commission. For more information, see How We Make Money.

Personal loans and personal lines of credit are two common options for consumers looking to borrow money without pledging a hard asset, like a home or car, as collateral. 

Although they have a lot in common, both have very specific applications based on needs. How can you determine which one is best for your needs? It’s all in how you intend to use the money. 

How Personal Loans and Lines of Credit Are Similar

Both personal loans and lines of credit are financing provided to consumers by a lender. They are unsecured loans, meaning they are not guaranteed by a hard asset that the lender can repossess if the borrower defaults.

Based on your personal credit score and credit history, a lender could offer either option, based on why you want to borrow the money. Fundamentally, with a personal loan you get a lump sum, and with a personal line of credit you get the ability to withdraw money over a defined amount of time, up to a defined maximum.      

“Personal loans are more of a traditional borrowing arrangement, structured in such a way that you’re getting a sum of money to provide for something you need to buy or refinance, and you’re going to have a repayment schedule,” says Andy Laino, a financial planner for Prudential. “A line of credit behaves more like a credit card account, and you only use what you need and pay it back flexibly with a minimum payment.” 

The process for either financing line starts with an application, which is usually completed online. During the application, you will be asked to provide information about your assets, income, and debt. As with all financing applications, the lender will also request and factor in your credit report. 

If your credit, income, and debt-to-income ratio are satisfactory — according to standards that vary by lender — you may get an offer of financing. While unsecured personal loans usually range from $500 to $50,000, an unsecured line of credit can range from $1,000 to $100,000 depending on the borrower’s creditworthiness. 

How Personal Loans and Lines of Credit Are Different

Although there are similarities between both lines of financing, a personal loan and line of credit have completely different applications. The key differences between the two are in the interest rates, how funds are made available, and how you pay it back over time. 

Difference in Interest Rates

Personal loans offer a one-time lump sum with a structured monthly payment schedule. 

“Generally, personal loans have a lower interest rate than a personal line of credit,” says Jason Krueger, a financial planner with Ameriprise Financial, because with the latter the borrower cannot draw more money and must follow a repayment schedule. 

The average personal loan interest rate was 11.88% in 2020, according to Bankrate, but it can be as low as 10.3% for borrowers with excellent credit. That compares to an average around 16% for credit cards, according to CreditCards.com, which shares an owner with NextAdvisor and Bankrate.   

Difference in How Funds Are Disbursed

With a personal line of credit, borrowers can continually draw money up to the predefined credit limit. This gives them more flexibility, since they can take only the exact amount they need, over an extended period of time. If you opt for a personal loan, you will only get a lump sum once. 

Personal loans can be repaid over periods from six months up to seven years, depending on the lender, while personal lines of credit can be kept open for far longer, some even indefinitely. 

“A line of credit is more for those who have more short-term needs, or need liquidity, or want to have the flexibility of making a larger purchase, and pay it back” over a longer timeframe, says Tom Parrish, director of U.S. consumer lending product management for BMO Harris Bank.

Difference in Repayment

While a personal line of credit works similarly to a credit card, a personal loan is a more traditional loan option. Just like with a mortgage or car loan, personal loan borrowers will pay back the balance and interest with the same payment amount every month, while a personal line of credit will have variable minimum payments.

“With a line of credit, sometimes your minimum payment is less than the interest that accrues each month,” says Krueger. “So you actually see your account balance going up over time.” 

Should You Choose a Personal Loan or a Personal Line of Credit?

Before deciding between a personal loan or a personal line of credit, start by taking stock of your personal finances, and determine what you want to achieve with the money. While personal loans are a great option for one-time purchases, a line of credit may work better for ongoing expenses over a period of time. 

If you are considering a personal line of credit as a means to fund a large expense over time — for example an ongoing home renovation — you might also consider opening a credit card account offering an introductory period with 0% APR, which would give you at least 12 months with no interest payments. If you have a plan to pay off the balance before the expiration of the grace period, they can be a valid alternative — but make sure not to carry a balance, which would trigger a high interest rate.    

“What is the consumer trying to accomplish with the dollars they are looking to get?” says Parrish. “Do you want to make sure you pay an expense off over a set period of time at a fixed rate, or would you rather put that on a line of credit, which fluctuates based on the prime rate?”

When to Choose a Personal Loan

Personal loans may be the best option for those who are considering a one-time expense, such as consolidating credit card and other debt under a lower interest rate, or are making a single major purchase. Because consumers don’t necessarily need great credit to qualify, personal loans can offer a convenient way to rebuild credit, or finance a purchase that will last over a long period of time. 

“Personal loans are best used for debt consolidation, for people who have major medical expenses, or they know they will have some home repairs at a fixed price,” says Laino. “When you have more defined expenses or more defined projects, go with the personal loan.” 

When to Choose a Personal Line of Credit

A line of credit may be the best option for individuals and families who are looking to borrow more money than a credit card may offer, but still want the flexibility of paying the balance back over time. A line of credit offers liquidity to take on major expenses as they come, such as an open-ended remodeling project, or quarterly college tuition payments for a child. 

“I like people to have a line of credit in place to have them as a tool in their pocket,” says Krueger. “It’s just a nice way to have instant access to funds in the event of an emergency or an opportunity.”

Like an unsecured personal loan, a personal line of credit is not guaranteed by a hard asset like your home. If you have built up equity in your home, a home equity line of credit may be a better option, offering you a lower interest rate. The flip side is if you default on the loan, the lender can repossess your home. 

Making Sense of Your Lending Options

Although they have a lot in common, personal loans and personal lines of credit offer different ways to achieve your financial goals. Your best option will ultimately depend on your needs. If the expense you need to tackle is a single payment, you may want to go with a personal loan; if it is a recurring expense, and if you may require additional funds, a personal line of credit may be the better option.

Personal loans are good for debt consolidation or big purchases, while a personal line of credit can help you break major expenses over a period of time into smaller, more affordable pieces. 

If liquidity over an extended period of time is more important, a personal line of credit can help you achieve your goals with flexible payments. However, you should strive to pay more than the minimum due each month on a personal line of credit, and when you do tap the funds you have available, plan ahead to pay down your balance as quickly as possible. That way, you’ll minimize what you pay in interest when you use your personal credit line to fund a large purchase. But if you are looking for structured payments at a low interest rate, go with the personal loan.

In either case, consider taking on additional debt in general only when it is smart to do so; for example, to pay down higher interest debt, or to fund a home renovation that would end up boosting your home’s value.