Line of Credit vs. Loan: How to Decide What’s Best for You

When choosing between a loan or line of credit for financing your personal or business needs, both have their pros and cons. And there are even situations where you might want both.

Understanding how each works and how they can help you determine what’s best for you.

What Is a Line of Credit?

A line of credit is a flexible account that gives you the option to borrow money quickly when you need it. Similar to a credit card, a line of credit has a maximum credit limit. You can take out loans (called draws) against your credit line, and you only pay interest on the amount you borrow.

What Is a Personal Loan?

Personal loans are typically unsecured installment loans. With a personal loan, you’ll receive the entire monetary amount upfront, and then repay it plus interest in regular installments over its repayment term.

Personal Line of Credit vs. Personal Loan

Both loans and personal lines of credit can be useful financial tools, but one might be a better fit than the other depending on your circumstances.

With a personal line of credit, you can get approved once and make multiple draws as you need the money. You’ll only pay interest on what you borrow, which can make a line of credit a more flexible and inexpensive option if you aren’t going to be tapping into the money (or need a large amount) right away.

Many personal lines of credit are also revolving credit accounts, meaning your available credit frees up as you make payments. A credit card is an example of a revolving credit account: the card has a limit of what you can borrow, and you can continuously borrow and pay off that debt. Like a credit card, lines of credit often have variable interest rates, which means your rate and payment might fluctuate over time.

A personal loan can be a better fit if you know how much money you need or if you plan to use the full amount right away. Unlike lines of credit, personal loans tend to have fixed interest rates. As a result, it’s easy to determine your total costs upfront and plan your budget accordingly.

However, if you find you want to borrow more money later on, you’ll have to reapply for another loan. Often, reapplying can be easier the second time around, especially if you’re doing it with the same lender who already knows you and if your income and credit profiles have remained stable.

When to Consider Using a Personal Loan

An unsecured loan can be a good fit when covering major expenses, like unexpected medical bills, home repairs, home improvements, or a wedding. You can often apply and get the funds within a few days, and many lenders will transfer the funds directly to your bank account. You can then use the money for almost anything.

A personal loan can also be a good option when you’re paying down high-rate debt, including credit card debt. Taking out a low-rate loan to consolidate your credit card bills can help you save money on interest and may lower your monthly payment. Reducing your debt can also increase your credit score.¹

When to Consider Using a Line of Credit

A line of credit may be a better fit if you have an ongoing project and on’t want to start accruing interest on the entire loan amount right away.

For example, you can use a line of credit for a project that requires payments every few months or if the total cost is unclear. Having a line of credit to tap during emergencies can also be beneficial, although you may have to pay fees to keep it open, even if you’re not using it.

In some cases, using a secured line of credit—like a home equity line of credit (HELOC)—could be a good option, particularly if you’re using the money to improve your home. But a HELOC typically requires you to have equity in your home and pay closing costs, whereas a personal line of credit does not.

Business Line of Credit: How it Works

A business line of credit is similar to a personal line of credit, but it’s used solely for business purposes. Many businesses have money flowing into and out of their accounts throughout the month, and having a line of credit available can help smooth out cash flow inconsistencies if there isn’t an immediate need for extra funds.

Businesses can also take out business loans, which are installment loans and work more like a personal loan. These can be useful if you have a general idea of the amount you’ll need—for example, to cover start-up costs or a large, unexpected expense such as business-related loss expenses not covered by insurance.

For many small businesses, the owner’s personal credit report along with the business’s credit and finances will determine the company’s eligibility and rates for both a business line of credit or loan.

Business Line of Credit Use Cases

A business line of credit is usually best for making periodic payments or covering ongoing needs.

Pay for a medium-term project

Sometimes companies need money for a major investment that will require ongoing payments, like a multi-month marketing campaign. A line of credit allows you to take an initial draw to get the campaign going, and quickly borrow money later to invest in the initiatives that are performing best.

Cover unexpected expenses

A line of credit allows a company to repeatedly borrow money without having to apply for new loans, which can be helpful to cover unexpected expenses or a surprise opportunity. For instance, a company may need to turn down a major order from a new client if it can’t quickly get funds to pay for the upfront costs of supplies. An open line of credit could prevent that issue.

Smooth cash flow

Given their flexible nature, companies can also use a line of credit to smooth cash flow problems. Businesses that sell products or services to other businesses may have to wait 30 to 90 days to get paid, and having a line of credit can help them cover payroll and other short-term expenses.

Business Loan: How it Works

There are many different types of business loans, and each works a little differently. But in general, they tend to work similarly to personal loans. A lender gives capital to the business upfront, and in exchange the business repays the principal with interest and fees. In most cases, business loans are repaid on a set schedule, but repayment terms and interest rates vary depending on the business’s credit.

If the business is fairly new or doesn’t have an established credit history, lenders sometimes rely on the founder or CEO’s personal credit score. This is because most business loans require a personal guarantee that you’ll pay back the debt with your own assets if the business cannot.

Business Loan Use Cases

A business loan can be a better fit for one-time expenses or large, anticipated costs. With a business loan, you receive the full amount upfront and may get a lower, fixed interest rate compared to a line of credit.

Purchase business equipment

Businesses often finance large equipment purchases and real estate leases with a business loan rather than a line of credit. Unsecured business loans are available for major purchases, although many require the business owner to sign a personal guarantee—which means they will be responsible for repaying the loan if the business isn’t able to afford the payments.

Lock in low monthly payments

A business may prefer an installment loan if it wants to be certain that it can afford the monthly payments without impacting its cash flow. A business loan with a fixed interest rate offers certainty because the payment won’t change in the future. And long repayment terms can help you lock in lower payment amounts.

Refinance debt

Many businesses need to take on high-interest loans or use credit cards, particularly during the first few years in business. Just as consumers can take out debt consolidation loans, a company can use a business loan to refinance its debts, save money, and lower its monthly payments.

Requirements for Qualifying for a Line of Credit or a Loan

Qualifying for a line of credit or loan varies depending on the specific type of financing and the lender. You’ll generally need to meet the basic eligibility requirements, like being at least 18 years old and living in a state where the lender operates. Additional requirements can include:

Requirements for qualifying for a line of credit

• Good-to-excellent credit

• A steady income

• Collateral for secured lines of credit

Requirements for qualifying for a loan

• Fair-to-good credit

• A steady income

• Collateral for secured loans and many small business loans

How to Get a Loan or Line of Credit

A variety of financial institutions and financing companies may offer loans and lines of credit that fit your personal finance needs. Comparing options from several lenders can help you find the best fit.

Where to get a line of credit

• Banks and credit unions

• Online lenders

• Mortgage lenders (for home equity lines of credit)

Where to get a loan

• Banks and credit unions

• Online lenders

• Manufacturers (for equipment loans)

How to Apply

The application process will vary by the financial institution and whether you’re looking for a personal or business line of credit versus a loan. You may be able to check your rate and loan offers with a soft credit check, which won’t hurt your credit scores.

How to apply for a line of credit

Compare options from several lenders to identify the best fit. You’ll want to review the potential credit limit, annual or monthly fees, and any required initial draw amounts when making your decision. Then, submit applications to compare your loan offers.

How to apply for a loan

You also want to compare personal and business loan lenders before applying. When deciding, consider your APR—the total, annual cost of borrowing, including interest and any other fees you may be required to pay. You should also consider maximum loan amounts, potential repayment periods, and whether or not the lender charges prepayment penalties or application fees. Keep in mind a longer repayment period can lead to lower minimum monthly payments, but a shorter term can lead to lower interest rates.

Check your rate with several lenders to see which offer works best for you.

The Bottom Line

Whether it’s for personal or business use, a line of credit and personal loan both have their benefits and drawbacks, depending on your situation. If you need ongoing financing or a safety net, a line of credit might be your best option.

If you know the exact amount of money you need and want a fixed repayment schedule, a personal loan could help set you up for greater financial success. In either case, doing research and checking your rate before applying can help you get the best offers.

Line of Credit vs Loan FAQs

If you’ve just started exploring personal loans, you probably have a ton of questions. Here are some of the most common.

Is it better to get a personal loan or line of credit?

It depends on what you need. A line of credit can offer flexibility and let you take multiple draws without applying for a new account, which is convenient if you don’t know how much money you’ll need. But a loan may offer a lower interest rate, and the fixed monthly payments can make it easier to budget for and repay.

That being said, if you need ongoing funds, a line of credit could be your best option. But if you know how you plan on using the money, a personal loan could offer better interest rates and a simpler repayment schedule.

Is it bad to get a line of credit?

Opening a line of credit isn’t bad, but review the account’s terms carefully to make sure they align with your financial needs. For example, some lines of credit will charge you a monthly or annual fee, even if you don’t use the credit line, and could potentially negatively impact your your debt-to-income ratio and credit score.

What is the benefit of a line of credit?

A line of credit can offer flexibility as you’ll be able to borrow up to your account’s credit limit, but you aren’t required to borrow more than you need. You also only pay interest on the amount you borrow.

Do I need good credit to get a loan or line of credit?

Some lenders offer loans and lines of credit to borrowers with poor credit, but there may be high interest rates and fees.

1 Reducing debt and maintaining low credit balances may contribute to an improvement in your credit score, but results are not guaranteed. Individual results vary based on multiple factors, including but not limited to payment history and credit utilization.