Personal loans vs. line of credit: What’s right for you?

While both personal loans and lines of credit are about borrowing money for a specific thing, they do function differently when it comes to how you borrow, the interest rates, repayment and access. 

We’ll go through the similarities and differences so you know what to look for if you’re deciding between the two.

What is a personal loan?

A personal loan is a fixed lump sum of money with monthly repayments over a specified period of time at a fixed or variable interest rate. You pay interest on the entire amount and once it’s paid off, the loan is closed and you no longer have access to it. You can get personal loans from financial institutions like banks or credit unions, or from private lenders. 

The money from a personal loan can be spent for any purpose, but common uses include major purchases like appliances, emergencies or to consolidate higher-interest debts.

Secured and unsecured personal loans

There are two main types of personal loans: secured and unsecured. 

A secured personal loan uses an asset you already own, like a car or house, as collateral against the loan. If you don’t pay back the loan, the lender can take the collateral asset. 

An unsecured loan doesn’t need collateral. If you don’t pay it back, however, the lender could sue you or take money from your bank account. 

There are other personal loan types, such as a debt consolidation loan. These allow you to borrow money at a lower rate to pay off your other debts that have a higher interest rate, like credit card debt, for example. Then you have one loan at a low interest rate to pay off, which is usually easier than trying to juggle multiple payments for different loans. 

What is a line of credit?

A line of credit (LOC) gives you ongoing access to a set amount of money at a variable interest rate. Unlike a personal loan, you still have access to it after you’ve paid it off. You can apply for a line of credit at banks or credit unions. 

Unlike personal loans, there is no set monthly repayment amount. You do have a minimum monthly payment but you can pay as much as you want per month. The interest rate also tends to be lower than for a personal loan, usually 1% to 2% plus the prime rate, which is based on the Bank of Canada’s benchmark Overnight Lending Rate. 

While it depends on the type of line of credit, these funds can be used for pretty much anything you like: renovations, as a consolidation loan for paying off credit card debt, paying your home or business expenses. 

There are different types of lines of credit. A very popular one is the personal line of credit, which is usually unsecured and doesn’t need collateral. Then, there are secured lines of credit where you provide collateral to get the loan. You get a lower interest rate than an unsecured line of credit, but if you don’t pay it back, you could lose your collateral asset. 

Home equity lines of credit (HELOCs) are an example of a secured line of credit. The collateral is usually your house. 

A business line of credit lets you borrow money to support your business. A subsection of business lines of credit is the demand line of credit. It’s pretty much the same, but the major difference is that the lender can demand full repayment at any time. 

Securities-Backed Line of Credit (SBLOC) or an investment line of credit allows you to use your investments as collateral for the line of credit. 

If you’re a student, you could get a Student Line of Credit, which you can use for tuition, books and housing. 

To qualify for either option, you need to: 

• Have Canadian residency
• Be of the age of majority in your province or territory
• Show income proof. Lenders want to see employment history and income because they want to know that the borrower can pay back the loan.
• Go through a credit check. Most lenders require a minimum credit score, usually 660. The higher your credit score, the better the chance of getting a good (read: lower) interest rate. 

Both personal loans and lines of credit have interest rates. Personal loans generally have a higher interest rate compared to lines of credit. 

• You don’t need collateral for most loans
• You can use it for major purchases
• Fixed payments means you can budget in advance with no surprises

• You could lose your home or car if you default on a secured loan
• Interest rates are higher than for a line of credit
• Missing a payment could affect your credit report and your credit score
• You pay interest on the entire borrowed amount

• You can use it for major purchases
• You don’t need collateral for most LOCs
• Interest rates are lower than a personal loan
• There isn’t a fixed monthly amount, so you can pay it off faster
• You only pay interest on the amount borrowed, not the entire line of credit

• Interest rates can go up due to a variable rate
• Temptation to overspend because you can borrow off your line of credit and just pay the minimum monthly amount
• You could pay a lot of interest on the borrowed amount due to just paying the minimum monthly amount

Also read:

• Best personal loans in Canada
• Predatory lending and payday loans: What it is and how to avoid it
• Home equity line of credit