Personal Loan vs. Personal Line Of Credit: What’s The Difference?

When it comes to paying for some of life’s big-ticket items — like a home renovation, a wedding or even a funeral — many people opt to use credit over cash. And credit can be especially useful when an expense sneaks up on you and you just don’t have enough in your emergency fund to cover the entire cost.

A personal loan and personal line of credit are both forms of credit you may consider turning to. And while they may sound like the same thing, they actually have some very important differences.

Read on for Select’s breakdown of what you need to know about the difference between a personal loan and a personal line of credit.

A personal loan is a form of credit that’s given to you as a lump sum amount. You can use it to pay for just about any large purchase – home renovations, funeral expenses, medical bills or even unexpected emergencies if you don’t already have an emergency fund.

People also use personal loans as a form of debt consolidation. Basically, they apply for a personal loan for a specified amount of cash and then use the money to pay off one or more credit card balances that have higher interest rates than the personal loan they just took out. This can help you save on interest payments when you take out a personal loan with a low interest rate, like LightStream, which offers rates as low as 2.49%* if you pay using autopay.

There isn’t really a hard-and-fast rule about what the loan must be used for, but you’ll usually have to explain the purpose of the loan when you apply for it. You might even consider using a personal loan to start a small business, but just make sure the lender doesn’t prohibit the use of funds for business purposes (you can read through their terms or ask the lender directly).

You’ll have to pay back the loan amount with interest in fixed, equal amounts each month for a prearranged amount of time (called the term of the loan). Because of this, it’s what’s known as installment credit. Personal loans usually carry a term of two to five years, but they can sometimes be repaid over the course of seven years.

Of course, there are many options out there, but you can make sure you’re getting a personal loan with the best interest rate by comparing different lenders. You can use this comparison tool from Even Financial to determine your top offers. The service is free, secure and won’t affect your credit score if you don’t apply for a loan.

Editorial note: The tool is provided and powered by Even Financial, a search and comparison engine that matches you with third-party lenders. Any information you provide is given directly to Even Financial. Select does not have access to any data you provide. Select may receive an affiliate commission from partner offers in the Even Financial tool. The commission does not influence the selection in order of offers.

Much like a personal loan, a personal line of credit (or PLOC for short) can also be used for large expenses. However, it is a form of revolving credit — just like a credit card.

Personal loans carry fixed interest rates while personal lines of credit usually have variable rates over time — it’ll depend on the change in the prime rate set by the institution lending you money. But for the most part, a higher credit score can help you get lower interest rates.

According to the Federal Reserve, the current average APR for a two-year personal loan is 9.58%. ValuePenguin notes that although variable, the interest rate on a PLOC can range from 9.30% to 17.55%, but some lenders, like First Republic, can offer rates as low as 2.25%. By contrast, the average interest rate on a credit card is 16.30%, but can be as high as 24%.

However, some credit card issuers offer a 0% intro-APR period, which could save you money if you do a balance transfer to pay down debt or are expecting to make a large purchase. Just make sure you know how long the offer period lasts.

The Citi® Double Cash Card, for example, lets you make a balance transfer without paying interest for the first 18 months (after, 13.99% – 23.99% variable). Balance transfers must be completed within four months of account opening.

A personal loan lender may charge an origination fee and/or an early pay-off fee (also known as a prepayment fee) if you pay off the loan before the end of its term. If you’re new to personal loans and want to save as much money as possible, you might consider one that doesn’t have an origination fee, like a Discover Personal Loan. 

And while lenders don’t usually charge an early pay-off fee for personal lines of credit, they do have a few other fees of that come with this specific type of loan. An annual fee during the draw period can run you between $25 – $50. A late payment fee can be around 7.5% of the amount that was past due. And if your payment bounces back due to insufficient funds in your account or because of a closed or frozen account, you can also be charged a return payment fee of at least $25.