Loan vs. Line of Credit
Both loans and lines of credits provide financial assistance to the consumers and businesses. The money borrowed can be used without any restrictions. However, the purposes to opt for a loan or a line of credit are – to pay for purchases, clearing previous debts, pay some urgent bills, to fund some temporary business requirements, or to pay medical bills.
When talking about loans, loans are further divided into few categories such as – secured & unsecured loans. Under which mortgages loans such as home loans and car loans come under the category of secured loans. Whereas loans such as- personal loans, Instant loans, credit card loans come under unsecured loans.
However, the main difference between a loan and a line of credit is the way they offer money to the applicants, and how the borrowers repay it back. Another major thing that differentiates both of them is- A loan is that financial assistance which offers you a lump sum of money that you are bound to repay over a fixed term. The tenure period is mentioned in your loan agreement and depends mostly on the amount you borrow & interest charged on it. Whereas a line of credit refers to a revolving account with a lender. With a line of credit get a fixed upper limit from which you are free to withdraw as per your requirement. A plus point with a line of credit is- it allows repay and redraw from available funds.
The key differences between loans and lines of credit include:
- How you receive your funds
- The flexibility you have to borrow
- The Way interest is charged
- How you repay the loan
The Difference Explained in details-
Making the difference more understandable – Loans are always better for large and single time requirements. One can also opt for a loan when the requirement is not a single time but he/she is aware of the total estimated expense. This is suggested because- when opting for a loan you get funds at a time. So, whether it is purchasing a new home or car, or paying for your home renovation, loans work best in these conditions.
Lines of credit, on the other hand, are suggested for small and unanticipated expenses. You can also opt for a line of credit when your income is not fixed and you need to add some money to your monthly budget. You can also apply for a line of credit to manage the cash flow of your new business.
Let’s understand this with an example to make it clear- When you are a salaried employee, you know how much you are going to get at the starting of the month. Hence you can plan your expenses and finances accordingly. But a small business owner can never know how much he is going to earn at the end of the month, so opting for a line of credit can help him to run the business supplies and purchase business materials in tough times.
This is also suggested as the business owner is unaware of his requirements and on the same hand he is unaware of the amount which he will need.
Generally, loans have both fixed & floating interest rates. So, if you avail a loan at an interest rate of 10% as a fixed interest rate, then the rate will not change during the entire tenure period. But when you choose to go with floating rates the interest rate charged for your loan may vary with the market variations.
On the other hand, lines of credit have variable rates. Apart from this,
The interest charged for a line of credit is relatively high as compared to other loans. However, it can be lower than a personal loan or credit card. But, Interest is not charged unless there is an outstanding balance on the account. This means interest is only charged when you withdraw some money from your line of credit account.
Times when you should consider applying for a Line of Credit (LoC)
- When you are not sure- how much money you will need.
- When Your expenses are not fixed
- You need ongoing access to money
- You don’t want to apply for a loan again & again
Times when you should consider applying for a Loan
- When you know how much you need to borrow
- When your expenses are fixed and planed
- You want to set repayment costs
- When you have fixed income sources to repay the borrowed amount in a planned manner.
When you understand the contrasts between a line of c and credit and loan, it’s simpler to distinguish which kind of financial assistance you want. Generally, loans are best when you need funds at once whereas a line of credit can help you when you are in need of funds but your requirements are not fixed.
Regardless of what you opt for, always think twice before you borrow and compare in the market with other lenders for interest rates and other terms and conditions.