There may come a time when you don't have the funds to finance an important personal purchase. From debt consolidation to major life events, there are several options to help you cover costs without dipping into your nest egg — and among them are personal loans and personal lines of credit.
You may have heard of these common sources of financing in your search for the right loan type. While both personal loans and personal lines of credit are typically unsecured, meaning they don't require collateral, it's important to understand their similarities and differences before making a final decision.
What Is a Personal Loan?
Personal loans are generally structured as term loans, or lump-sum loans, which means you get all the funds at once and you repay the loan back consistently over time in fixed payments — and on a predetermined repayment timeline (the term of the loan). These loans are also referred to as installment loans.
How a Personal Loan Works
To obtain a personal loan, you apply for a certain amount of financing through a lender. Loan amounts offered by a lender may vary and the specific amount you receive will be determined upon whether you qualify for the amount requested, or a lower amount, based on your credit history. If approved you'll receive the funds as soon as the loan is issued.
With a lump sum loan, you'll be required to repay the loan in monthly installments (payments) over the designated repayment term. The interest rate on a personal loan is typically fixed, and interest begins to accrue once you receive the funds.
Your interest rate will be determined by your lender and is contingent on your creditworthiness and other factors. In addition to interest charged on the loan, there could be an origination fee with personal loans. Some lenders will also charge a fee for early repayment, while other lenders do not charge these fees. When you are shopping for a loan, be sure to understand what fees may be charged and compare Annual Percentage Rates (APRs), since the APR will include the interest rate plus fees and other expenses associated with the loan.
Qualifications for a Personal Loan
Your lender will determine their specific qualifications for a personal loan. Generally, lenders approve applicants with a strong personal credit history, which takes into account repayment of bills in full and on time.
Popular Uses of a Personal Loan
A personal loan is a flexible financing option that enables you to pay for a variety of different personal needs. For instance, this may include paying for a wedding, home improvements, a vacation, or a large purchase. Many people also use personal loans to pay down high-interest debt, including credit card debt.
What Is a Personal Line of Credit?
A personal line of credit is a type of unsecured financing that allows you to borrow (“draw”) up to your approved limit, repay your balance, and use it again.
The key feature of a personal line of credit is that it's a revolving type of account, which means you can draw from the line repeatedly, accessing the funds whenever you need.
How a Personal Line of Credit Works
The first step is applying with a lender. If approved, you're provided access to a specified line amount (“credit limit”). You are then able to draw any amount from the personal line of credit, up to that credit limit. The credit limit to which you'll have access will depend on how much you apply for, or a lower approved line amount, based on your creditworthiness. Lenders will often set minimum draw amounts, meaning you'll have to borrow at least a certain amount of money each time you access your funds.
Once you utilize the line of credit, you'll be required to make monthly payments which will vary each month based on the amount drawn, commonly referred to as the outstanding balance. You only pay interest on the outstanding balance rather than the entire amount for which you're approved. The line of credit allows you to borrow as many times as needed up to the maximum amount available. As you pay down your balance, your available credit line will increase, allowing you to take additional draws up to your limit. Paying off your balance as soon as possible gives you access to funding for future needs.
Interest rates for a line of credit are generally variable, which means the rate charged fluctuates as market interest rates (the “index”) change. In addition, your lender's guidelines as well as your credit history are factors into the interest rate for which you qualify. Personal line of credit fees may vary among lenders. Whereas some lenders may charge an origination fee when the line of credit is established or an annual maintenance fee, some lenders may not charge these fees. As with any financial obligation, be sure to understand and compare the fees and rates associated with lines of credit as you research options.
Qualifications for a Personal Line of Credit
Each lender will have specific qualifications for a personal line of credit. Generally, lenders approve applicants that are in good standing with their personal credit history. For instance, your credit card payment history can be a good indicator to a lender of your personal responsibility with financing.
Popular Uses of a Personal Line of Credit
Personal lines of credit offer flexibility since they can be used for a variety of purposes. Common uses include purchases, home improvements, debt consolidation, emergency situations, medical procedures, and more.
Personal Loans vs. Personal Lines of Credit
What is a personal loan, compared to a personal line of credit? This is a crucial question to answer before you choose the right financing.
Personal Loans vs. Personal Lines of Credit: Key Similarities
Personal loans and personal lines of credit are similar in the sense that they're both meant to finance personal purchases. Both require interest payments and have similar baseline qualification requirements. They are often available as unsecured loans, which means you don't have to put up collateral to borrow money — a less risky option than secured loans.
During the application process, both require what's known as a hard credit check, which means your credit will be reviewed and your credit score impacted when you apply, often going down a few points temporarily. However, making payments on-time and repaying your outstanding loan or line balance in full may ultimately help boost your credit score.
Personal Loans vs. Personal Lines of Credit: Key Differences
The main differences between these two types of financing include:
Loan structure: Personal loans are distributed as one lump sum; you'll need to apply for financing again if you need access to more money in the future. Personal lines of credit are borrow-as-you-need, which you can access on a rolling basis up to the credit limit.
Loan amounts: Although amounts offered may vary by lender, personal loans are often available in higher amounts than personal lines of credit.
Interest: With a personal loan, you’re responsible for paying interest on the entire amount you borrowed, as it’s a lump sum delivered to you once. With a personal line of credit, you only pay interest on the amount of funds you actually use. Interest is also structured differently: personal loans usually have a fixed rate while personal lines of credit have a variable rate. Interest rates are typically lower on a personal loan than on a personal line of credit.
Repayment terms: Personal loans require fixed payments on a pre-determined repayment schedule. Because you determine the amount you draw from a personal line of credit, you'll only have to repay what you borrow and the payment amount will fluctuate depending on how much you have drawn from your approved funds.
Fees: Fees will vary between these two types of products. You may pay recurring fees such as an annual fee and/or a small fee each time you draw from a personal line of credit, whereas you won't incur that type of fee with a personal loan since you access all those funds at once. For a loan, a one-time upfront origination fee may be charged. For either product, in addition to any standard fees the lender may charge, you may incur fees triggered by scenarios such as making late payments.
Qualifications: Ultimately, lenders will determine the qualifications for any type of loan.
Use of funds: Although both can finance personal purchases, the types of expenditures you are looking to finance is a consideration when comparing the two. Personal loans are often best suited for larger purchases that need to be paid for at once. Personal lines of credit are often well-suited for smaller, short-term, or recurring purchases.
Tips for Choosing the Best Option for You
The good news: there are many options for personal financing. As you pursue funding for a personal purchase, it can be key to choose the right product, since you could ultimately pay lower fees and save money by making the best choice to meet your needs. The first step is knowing the similarities and differences between personal loans and personal lines of credit, as outlined above.
As you decide between these two types of financing, you should think about the purpose of your loan and if you'll possibly need money down the line. Some key questions to ask yourself:
- What are you trying to finance? Is it a relatively small expense, or will it require significant capital?
- Is it a one-time purchase, or will it be ongoing?
- Do you know exactly how much money you'll need to pay to make your purchase, or is the amount indeterminate?
- How much are you comfortable paying each month? How much control would you like over how much money you'll owe a lender each month?
- Do you need immediate access to the full amount, or can you get it by accessing smaller amounts periodically?
- If you need more money in the future, are you comfortable with applying again, or would you prefer to have instant access to a revolving source of funds?
Another important consideration is your personal financial situation. It's vital to assess how much you can realistically repay each month, and whether your income is stable enough to support the payments. For instance, it may be difficult to commit to a personal loan with a fixed, long-term repayment schedule if you don't have a secure monthly income. Or, if on a strict budget, it may be hard to commit to a personal line of credit in which the payment may go up or down each month.
Remember, too, that your choices are often dictated by your finances. If you have a strong credit score and solid repayment history of past borrowed money, you may have more personal loan and line of credit options, which generally offer more favorable terms for those with good creditworthiness.
If you feel you may not have a strong enough credit history to qualify for a personal loan or personal line of credit, however, you're not out of options. You may be able to start with a personal credit card to access some funding. This can help improve your credit score and eventually help you qualify for a personal loan or personal line of credit down the line.
If you have questions about your credit score and financing options, it can be helpful to consult a financial professional.
To learn more about what PNC has to offer, check out PNC's personal loan options.