The loans vs line of credit discussion come up every time someone needs money. Simply put, both are tools that allow individuals as well as businesses to make purchases or incur various types of expenses. In the discussion of loans vs lines of credit, it is essential to understand the nuances of both. Thereby allowing you to make an informed decision and decide for yourself if a line of credit is better than a loan or not.
Almost all loans have a non-revolving credit limit. In other words, a borrower has access to all the funds at once, and then they need to repay both the principal and the interest till the entire debt is paid off.
In comparison, a line of credit has a revolving credit limit. The borrower usually receives a defined credit limit, and they need to pay the principal and interest together for the limit that they use. However, unlike a loan, in a line of credit, you can borrow more money as long as the line of credit is active and there is a credit limit available.
Loan Vs Line of Credit – Definitions
If you wish to understand the difference between a line of credit and a loan, knowing a bit about loans and lines of credit individually will aid you in the process.
Loan
A loan is a specific amount that depends on the creditworthiness of the borrower and their needs. The loan is a lumpsum amount that is designed for one-time use. Thus, you cannot use the loan amount repeatedly. Here are the major types of loans.
Vehicle Loan
A vehicle loan is a secured type of loan, where the vehicle is the collateral. The lender usually pays the amount to the seller of the vehicle, apart from any down payments that you might have made. The borrower must pay the installments regularly till they pay it off entirely.
Mortgage Loan
It is a secured loan that lets a borrower buy a home or property and that serves as collateral. The borrower must regularly pay interest and principal once the lender pays the amount for the mortgage. The interest rates are a bit lower than other loan types.
Student Loan
It is a type of loan used to fund educational qualifications. Most of the time, these loans rely on the income and credit rating of the parents, but the children are responsible for the repayment of the loan. You do not have to repay anything till the end of the course or up to 6 months after the completion of a course.
Business Loan
Business loan are used by small, medium or large-scale businesses for a variety of needs. The loan can be used for day-to-day operations, hiring staff, buying more inventory, and so on.
Line of Credit
A Financial institution or bank provides a line of credit to borrowers, which is a bit like credit cards. The borrower can keep using the credit limit multiple times, unlike a loan. You can use a line of credit for a variety of needs, such as a trip or paying off a debt that is on high interest, home renovations, etc.
The usage of the line of credit impacts the credit score much more than other financial products. It impacts the credit score much faster and has a more significant impact as well.
For a line of credit, the interest rate is a bit high, and it requires smaller payments as compared to loans. The monthly payments comprise principal and interest. There are different lines of credit for different consumers.
The following are the different lines of credit that you must be aware of.
Personal
It is an unsecured line of credit and does not have any kind of collateral. They require the borrower to have a higher credit score, and the line of credit is usually for smaller amounts but with higher personal loan interest rates.
Business
This line of credit is given to businesses on a need basis. The lenders usually consider the profitability of the business along with the risks to decide on the credit limit. The line of credit can be secured or unsecured, as it depends on the amount that is requested. The business loan interest rates can also vary depending on the other factors.
Loans vs Line of Credit - Differences
Here is some of the difference between a line of credit and a loan.
Loans
Line of Credit
The borrower gets access to the entire loan amount just once, as a lump sum amount.
You can use the available credit limit at any time, pay the amount back and borrow again.
The lender will start charging interest as soon as you borrow the entire loan amount.
The interest accrues only when you borrow from the credit limit and applies only to that borrowed amount and not the entire credit limit.
There usually needs to be a specific purpose or need, such as to buy a car or home or education.
You can use the borrowed amount for anything that you wish to do.
The cost of closing a loan is higher than that of a line of credit.
The interest rate is higher than that of a loan.
Loan amounts are usually higher, and they require a higher repayment also.
A line of credit usually offers a lower credit limit and a smaller repayment.
Loans vs Line of Credit – Disadvantages
Loans are not inherently flexible, and you could end up paying interest even on money that you are not utilizing.
A line of credit, on the other hand, is a bit more expensive due to the higher interest rates, and the lower limits can be a bit concerning for some.
Wrapping It Up
Though both products provide the borrower with purchasing power, they are quite different. There is a lot of difference between a line of credit and a loan, as we saw above. And to answer the question, "is a line of credit better than a loan?'; it would come down to your requirement and personal preference. Each of them has its pros and cons, and the loans vs line of credit section will help you decide that better. However, if you wish to weigh the same yourself, you could consider loan options from Tata Capital.
06 February 2024
6 mins read
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