Loans and lines of credit allow consumers and businesses to borrow money for making purchases or incurring expenses. Some of the examples of loans and lines of credit include mortgages, credit cards, home equity lines of credit and auto loans. The key difference between a loan and a line of credit is how you get the money and how and what you repay. A loan is a lump sum of money that is repaid over a fixed term, whereas a line of credit is a revolving account that lets borrowers draw, repay and redraw from available funds.
A line of credit is similar to a credit card since it is a flexible borrowing solution. You can draw on this revolving loan simply by writing a check. You are also able to borrow any part of your credit line again once you have repaid it. There are no payments until you use your line.
With a personal loan, you receive the whole loan when you are approved and you start paying interest immediately on the full amount. You have a fixed schedule of payments that will reduce until the loan is paid off.
What is a Loan?
The loan typically refers to an instalment loan. When you take an instalment loan, the lender will give you a lump sum of money that you must repay with interest in regular payments over a period of time. Many loans are amortized, which means that each payment will be the same amount. Most people will take some type of loan throughout their lifetime. Generally speaking, people will take loans to purchase or pay for something they couldn’t otherwise pay for outright -- like a house or car. Common types of loans that you may encounter include mortgages, auto loans, student loans, personal loans and small business loans.
What is a Line of Credit?
A line of credit is a revolving account that lets borrowers draw and spend money up to a certain limit, repay this money (usually with interest) and then spend it again. The most common example of this is a credit card, but other types of lines of credit, such as home equity lines of credit and business lines of credit also exist.
Which is Better, Loan or Line of Credit?
In general, loans are better for large, one-time investments or purchases. Whether it is the purchase of a new home or car or paying for a college education, loans remain the first choice.
Lines of credit are better for ongoing, small or unanticipated expenses or to even out income and cash flow. For instance, a small business owner might use a credit card to pay for office supplies and materials every month. A homeowner might take out a home equity line of credit to pay for ongoing remodelling costs when she isn’t sure how much the project will cost.
Loans usually have fixed interest rates. This means that if you take out a loan with a 5% interest rate, that rate will not change during the life of the loan. Many lines of credit have variable rates.
With a personal loan, you’ll begin accruing interest on the full loan balance right away and will be responsible for making fixed payments over a set period of time. With a line of credit, however, you won’t have to pay interest until you draw on the line, and you’ll only be charged interest on the outstanding balance you carry.
Having a line of credit means having access to funds you can use and repay over and over again within a certain time frame. This can be handy when it comes to big projects like a home remodel, where expected costs can shift. It could rid you of the hassle of having to find an extra source of cash when costs come up down the line.
When is it best to opt for a line of credit?
You can opt for a line of credit when:
You’re not sure how much money you’ll need
Your expenses may be spread out over a period of years
Your credit is in good condition
Is a personal loan a good choice?
A personal loan can be a good choice when:
You know how much you need to borrow
You want to limit the amount of debt you take on
Do personal loans and line of credit require a good credit score?
Yes. If you are looking to avail competitive interest rates then a good credit score can help in availing loans and line of credit at better interest rates and other loan terms.
Loan and line of credit are good sources of finance. However, before applying for a loan or a line of credit, it’s important to consider how much financing you’ll need in the long and short term, as well as the condition of your credit, to help you make the best decision for you.