Both personal loans and personal lines of credit allow you to borrow money without needing collateral. However, they differ in the way they distribute funds and manage repayment.
Let’s look into how personal loans and personal lines of credit work, how to compare them and how you can choose between the two when considering them for your financial needs.
What is a personal loan?
A personal loan is money you borrow in a lump sum and repay to the lender in fixed installments. Funds from a personal loan can be used for any purpose you choose, from repaying a debt to making a purchase.
Personal loans are usually unsecured, which means borrowers don’t need collateral to access one. Banks and other lenders provide loans based on eligibility criteria, including income and creditworthiness. These factors may also impact the interest rates and loan terms that the lender offers you.
How does a personal loan work?
To apply for a personal loan, borrowers will submit an online or in-person application form along with documents such as proof of identity, home address, employment and income.
When you’re approved for the loan, you’ll receive the funds all at once as a deposit into your bank account. Sometimes, an application may be processed quickly, with eligible borrowers receiving funds the same day.
The repayment process starts soon after the borrower has received the funds and continues until the loan term ends. Loan terms usually vary from one to seven years, but may last as long as seven years.
What is a personal line of credit?
A personal line of credit (PLOC) is a revolving credit account—similar to a credit card—that lets you borrow funds for expenses at any time up to a specific credit limit. Personal lines of credit have a variable interest rate which may fluctuate with market changes.
How does a personal line of credit work?
A personal line of credit lasts for a fixed amount of time, called the draw period. To make withdrawals, you may have to write checks or transfer funds into your checking account.
You may withdraw as much as your credit limit will allow during the draw period. You can also continuously repay what you borrow.
As you repay what you borrow, your credit will be replenished. Once the draw period ends, you must reapply for a line of credit if you want to continue the service.
Unlike personal loans, a personal line of credit does not provide you with funds in the form of a lump-sum payout. Once your application for a personal line of credit is approved, you can withdraw from your credit account at a bank or electronically transfer funds into a checking account.
Similarities Between Personal Loans & Personal Lines of Credit
You can use personal loans and personal lines of credit mostly at your discretion. Apart from flexibility of use, though, these forms of credit have a few other factors in common.
To be eligible for personal loans or PLOCs, borrowers need to meet the lender’s criteria for creditworthiness and income. Good credit helps your application, but while some lenders will offer personal loans to borrowers with comparatively worse credit, it may take more work to find a PLOC when you have poorer credit.
Hard Credit Inquiry
To see if you meet the standards for creditworthiness, lenders will need to conduct a hard credit inquiry into your credit file. This may hurt your credit temporarily.
Differences Between Personal Loans & Personal Lines of Credit
While personal loans and personal lines of credit have some similarities, they have different interest rates, repayment terms and disbursal processes.
Personal lines of credit incur variable interest, which means your rate is subject to market fluctuations. Personal loans have a fixed interest rate that stays the same throughout the loan term. Personal loans involve borrowing a fixed amount, so you pay interest on the lump sum. However, with a PLOC, you pay interest only on the amount you borrow, even if it is less than the given credit limit.
Distribution of funds
With a personal loan, a lump sum is deposited into your bank account for you to use as needed. With a personal line of credit, you access funds through withdrawals and bank transfers.
You can repay a personal loan in fixed monthly installments within a specified period that usually ranges from 1 to 5 years.
On the other hand, a personal line of credit does not require a set repayment plan. You’ll typically have a monthly payment throughout the draw period. Once the draw period is over, you may enter a repayment period during which you may repay the rest of the debt through monthly payments. In some cases, your lender may ask that you repay the entire borrowed balance at the end of the draw period. This is known as a balloon payment. Borrowers seeking a PLOC should look carefully at the repayment terms offered by their lender at the time of applying.
How to Choose Between a Personal Loan and a Personal Line of Credit
A personal loan is ideal when you're seeking a lump sum payment that you can use as needed. Since you only receive the funds once, it’s better to use personal loans when you know exactly how much money you need and how you intend to spend it.
Because of its flexibility, a personal line of credit can help you if you're still determining how much money you will require, such as during a large-scale home renovation. A personal line of credit may also help you fund ongoing expenses such as major home renovations.
Disclaimer: Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.