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

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A recent survey by Forbes Advisor returned some interesting results: nearly 68% of Americans applied for a personal loan in the past year— showing a significant jump of almost 13% according to TransUnion's findings. Yet, when it comes to personal lines of credit, they seem to be the road less traveled with less than 10% of Americans tapping into this valuable form of borrowing. Both offer distinct paths to financial flexibility, coming with their own sets of rules and benefits.

While personal lines of credit are a financial cushion, bracing you in the case of unexpected expenses or pre-planned projects, personal loans instead provide you a one-time boost of cash that gets repaid over time (reapplying each time you need to borrow). Which is better depends on who you are as a borrower and the circumstances of your specific situation. What’s important is to understand the difference between personal loans vs personal lines of credit, and how each can be leveraged into making smarter financial decisions.

Understanding Personal Lines of Credit

If you've ever wished for a little financial wiggle room without diving headfirst into a sea of debt, let's chat about personal lines of credit. A personal line of credit is like your friendly neighbor who's there to lend some cash when you're in a pinch. Much like a credit card, it gives you a pool of funds to dip into as needed, acting as a financial backup plan when you need it, without the pressure to use it all.

The best part? As you pay back what you've borrowed, that amount may become available again for future borrowing. This is fantastic for ongoing projects or just to smooth out bumps in your financial road. But, heads up, personal lines of credit with variable interest rates could cause your rate to fluctuate with market conditions, leading to paying more or less over time.

Read more: How to get a line of credit with bad credit

Advantages of Personal Lines of Credit

Borrowing flexibility: Use as much or as little of your credit limit as you need.

Potentially lower interest rates: Tends to be cheaper than regularly maxing out credit cards.

Credit score impact: Has the possibility of improving your credit and showing financial responsibility when used properly.

Disadvantages of Personal Lines of Credit

Variable interest rates: If your line of credit has variable interest rates, it could mean that your payments go up or down over the course of repayment.

Possible fees: Look out for sneaky charges.

Not always easy to qualify: You'll need decent credit to get a line of credit.

When considering a personal line of credit, review pros and cons by understanding the terms, conditions, and associated costs, while ensuring that you can comfortably manage repayment obligations.

Read more: Secured vs unsecured lines of credit: What's the difference?

Understanding Personal Loans

A personal loan is an installment loan in which you borrow a specific amount of money and repay it in fixed monthly payments over a set period. Unlike a personal line of credit, which allows you to draw funds as needed, a personal loan provides a lump sum of money upfront, which can be used for a variety of purposes, such as debt consolidation, home improvements, or financing a major purchase. However, personal loans are usually a one-time lend, meaning reapplication must occur each time you need to borrow additional funds.

Advantages of Personal Loans

Fixed monthly payments: Personal loans typically come with a set repayment term and fixed interest rate, allowing you to more accurately plan your budget around loan payments.

Potentially lower interest rates: Personal loans often have lower interest rates than credit cards, making them a more cost-effective borrowing option that is great for debt consolidation.

Credit score impact: Making consistent on-time payments on a personal loan can help improve your credit score over time.

Disadvantages of Personal Loans

Less flexibility: Once you receive your lump-sum payment, you cannot borrow additional funds without applying for a new loan.

Origination fees: Some lenders charge origination fees, which can range from 1% to 8% of the loan amount, adding to the overall cost of borrowing.

Prepayment penalties: Certain lenders may charge fees if you pay off your loan early, so it's essential to read the fine print before signing any agreements.

Higher monthly payments: Since personal loans have fixed repayment terms, your monthly payments may be higher than the minimum payments on credit cards or personal lines of credit.

Before committing to a personal loan, take the time to shop around for the best offers, scrutinize the fine print, and confirm that you can comfortably manage the monthly payments.

Use Cases for Personal Lines of Credit and Personal Loans

Both personal lines of credit and personal loans could come in handy for a variety of scenarios where flexibility and access to funds are key. Here are some practical use cases for these borrowing options:

• Home Renovations and Repairs: Both personal lines of credit and personal loans provide substantial sums that can be used for significant home improvements or necessary repairs.

• Consolidating High-Interest Debt: Consolidating debts could help you secure a lower interest rate, simplify your payments, and streamline your finances.

• Funding Higher Education: Whether it's tuition fees or living expenses, both financing options can help cover the costs associated with pursuing higher education.

• Emergency Funding: In cases of unexpected medical bills, urgent travel needs, or last minute home repairs, personal lines of credit and personal loans can both offer necessary funds to supplement your emergency savings.

• Large Purchases: For making big-ticket purchases, both options can offer lower interest rates compared to credit cards, which can be beneficial depending on the terms and rates you qualify for.

• Wedding Expenses: Financing a wedding is a significant expense, and both personal loans and lines of credit can offer the financial support needed to cover various services and purchases.

Each of these scenarios showcases the accessibility of personal lines of credit and personal loans as flexible financial tools. They are powerful options for those who need access to funds over a period of time and can be used for a variety of purposes.

Choosing Between a Personal Line of Credit and a Personal Loan

Factors to Consider

When choosing between a personal line of credit and a personal loan, several factors should be considered before deciding on the best option for you.

Your Needs

Before looking to borrow funds, evaluate your financial needs and goals. Consider whether you require short-term or long-term financing and whether you have a specific purchase in mind or anticipate ongoing expenses. Answering these questions will help you choose the financing option that aligns best with your requirements.

Interest Rates

When comparing different borrowing options, don't just look at the advertised interest rates. Consider the Annual Percentage Rate (APR), which includes interest and other fees, to get a better idea of the total cost of borrowing. Make sure you also look for any hidden fees, such as origination fees, annual fees, or prepayment penalties, as these can significantly impact the overall cost.

Repayment Terms

Personal loans usually require a fixed repayment amount over a set period. On the other hand, personal lines of credit often provide more flexibility with variable repayment amounts. If you prefer a consistent monthly payment and a fixed expense, a personal loan is often the better option. However, if you want to better manage fluctuating cash flow with the ability to pay off debt early (without penalty), a personal line of credit may be more suitable.

Note: Varo Line of Credit¹ offers the best of both worlds— giving you a lump sum of money with fixed monthly payments, similar to a personal loan, while also allowing you the flexibility to pay off your debt early without penalties or the need to reapply each time you want to borrow again, mirroring a personal line of credit.

Eligibility

Lenders usually require higher credit scores and income for personal lines of credit due to their flexibility and the ability to draw funds repeatedly. However, this option offers unparalleled adaptability for ongoing expenses. Both options could lead to a hard credit inquiry, briefly affecting your credit score.

The Lender

Different lenders may offer distinct terms, interest rates, and fees for each borrowing option, reflecting their risk assessment and market positioning. Be thorough researching and comparing lenders, as some specialize in personal loans with competitive rates while others might offer personal lines of credit with greater flexibility or lower costs. Consider lender reputations, customer service, ease of managing your account, and whether they provide clear, transparent terms that align with your needs.

Which is Better for You?

Choosing between a personal line of credit and a personal loan starts with an evaluation of your financial situation. You may want to compare rates, fees, and repayment terms from multiple lenders, including alternative options. Be sure to review the fine print and budget out your repayment plan to ensure you can comfortably manage on-time payments.

Both personal lines of credit and personal loans offer specific benefits tailored to different needs. Personal loans are ideal for when you know exactly how much you need— for instance, for consolidating debt from various sources into one manageable monthly payment with a clear end goal in sight.

On the other hand, a personal line of credit shines in scenarios requiring swift access to funds, especially when facing unexpected or variable expenses. Traditionally, personal lines of credit might come with challenges, including prepayment penalties and elevated interest rates.

Meet Varo Line of Credit

If you’re looking for a unique personal line of credit without recurring interest, you should look at the Varo Line of Credit¹. Our product distinguishes itself by providing a personal line of credit that sidesteps many of the common pitfalls found in traditional line of credit offerings. Varo Line of Credit was specifically designed to help you in managing unplanned expenses or short-term cash flow challenges without hidden fees, late fees, or prepayment penalties. 

Instead, Varo Line of Credit allows customers to borrow between $600 to $2,000 (depending on the borrowing amount you qualify for) with a transparent, one-time flat fee. Repayment durations can be from 3 to 12 months, based on the amount borrowed.

Get started with Varo today or click to learn more about Varo Line of Credit!

^{1 The Varo Line of Credit is designed to help customers with unforeseen expenses with monthly payments, no late fee, no prepayment penalties, and no interest. To be eligible, your accounts must maintain a positive balance. Minimum monthly deposits, average daily balances, and other eligibility requirements apply. Once qualified for Varo Line of Credit, you will be assigned a credit limit from $600 to $2,000. A one-time fee is added to your borrowed amount, early repayment of your advance does not reduce the one-time fee. Your credit limit may fluctuate from one advance to the next based upon a variety of factors. You may only take one Varo Line of Credit out at a time. Your eligibility information and/or credit limit is always available to you in the home screen of your Varo app. Checking offer eligibility will not impact your credit score. If you are eligible and choose to apply for an offer, we will pull your credit and your credit score may be impacted.}