Personal loan vs line of credit: Which borrowing option is right for you?

You may find yourself without cash planning for travel, home renovations, medical bills, or schooling, and may contemplate a personal loan or line of credit. While personal loans and lines of credit are both financial instruments that allow you to access funds with some degree of liquidity, they do operate in very different ways.

In order to help you make up your mind about which loan option fits your financial goals the best we will look at the differences between the two.

What is a personal loan?

A personal loan is a sum of money that banks or financial institutions lend to you upfront. The loan is repaid over a certain period of time, typically between one and five years, in equal monthly payments (EMI).

Key features

• Fixed loan amount received all at once.
• Fixed repayment plan includes interest, making it a great option for unique, large expenses (e.g. wedding, debt consolidation).

What is the line of credit?

A more flexible option is a line of credit (LOC). LOCs are similar to credit cards, as you are approved for a limit, but you can use only the amount you need, when you need it. Interest is charged on only the amount used, not the entire credit limit.

Key features

• Revolving credit; money that can be used again once it's paid back.
• Interest is charged only on the amount used.
• Good for regular or random expenses.

Personal loan vs line of credit

1. Disbursement structure

• Personal loan: The amount is given one-time (up-front).
• Line of credit: Depending on your limit we draw down the amount on a per need basis.

2. Interest charges

• Personal loan: Interest is calculated on the full amount of the loan from day one.
• Line of credit: Interest is charged only on the amount you take out.

3. Flexibility of repayment

• Personal loan: You pay fixed EMIs until it is repaid.
• Line of credit: You can pay the full amount or minimum dues.

4. Feeling of reusability

• Personal loan: Once a loan is repaid, it's closed. You apply again for more funds.
• Line of credit: After repayment, it is available again without needing to apply.

5. Cost effectiveness

• Personal loan: Higher interest rates for infrequent or short-term borrowing.
• Line of credit: Is more cost effective for those who need regular access to funds.

Which option suits you better?

Choose a personal loan if:

• You have a specific financial purpose, such as paying for a wedding or buying a car.
• You prefer a fixed monthly payment.
• You simply need a large, one-time loan.

Choose a line of credit if you:

• Have changing or ongoing spending habits.
• Need flexibility with repayment and borrowing.
• Prefer to pay interest only on what you use.

In conclusion, while line of credit and personal loans both provide you options to meet your financial goals, a line of credit provides you more flexibility and control while a personal loan will provide you with more structure and certainty. Before making a decision consider your current financial situation, the type of spending you will be doing, and your personal comfort level with repayment.

Disclaimer: Mint has a tie-up with fin-techs for providing credit, you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards and credit score. Mint does not promote or encourage taking credit as it comes with a set of risks such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.