Two main types of credit are loans and lines of credit. Both are similar in letting people borrow money for various purposes, such as covering cash shortfalls, refinancing debt, or even going on vacation.
But each of these loans works differently in a few areas, and knowing the differences between the two can help borrowers determine which option is right for them. Let's dive deeper into how lines of credit and loans work and how they differ.
What is a loan?
A loan is money that a borrower can receive from a lender and pay back either all at once or over time, depending on the type of loan and repayment terms. Borrowers can get loans from banks, other physical lenders, and online loan sites.
There are many types of loans, including:
- Mortgages
- Auto loans
- Personal loans
- Cash advances
What is a line of credit?
A line of credit is a form of revolving credit. This means people can borrow as much as they need from it — up to a predetermined credit limit — and pay it back when they can. The lender will only charge interest on the amount the borrower takes out.
Some types of credit lines include:
- Personal lines of credit
- Business lines of credit
- Secured lines of credit
- Home equity lines of credit (HELOCs)
Differences between loans and lines of credit
Here are some notable differences between loans and lines of credit:
Schedule
Borrowers can take out a loan all at once and generally pay it back in fixed monthly amounts over time. For example, a borrower might repay a car loan monthly over 5 years.
On the other hand, borrowers can use their lines of credit at any time. Additionally, they can repay at their leisure, as long as they make at least the minimum payment on time.
Need
Borrowers often get loans for one specific purpose, such as buying a car or renovating a room in their home.
With lines of credit, on the other hand, borrowers can use them for multiple purposes since they can continuously borrow. In addition, lines of credit are sometimes used for everyday expenses, like groceries.
Interest
Loans accumulate their interest all at once or daily, but rates tend to be lower. That interest is factored into the monthly payment amount. On top of that, loans may have other fees, such as origination fees and prepayment penalties.
Lines of credit accumulate interest on the amount borrowed, but rates tend to be higher than on loans. However, credit lines generally have fewer fees.
Loans vs. lines of credit: different features, different purposes
Loans and lines of credit have a few differences, but neither option is better than the other. Instead, their differences in features make them serve distinct purposes.
Overall, loans can be excellent tools for single-purpose, significant expenses, such as renovations or the purchase of a home. Meanwhile, lines of credit can work well as an extra layer of financial security and provide access to funds when the borrower can't predict exactly how much money they'll need. Using both in their proper roles can help borrowers move forward financially.
Notice: Information provided in this article is for information purposes only. Consult your financial advisor about your financial circumstances.
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Original Source: Advance America: Loans vs. Lines of Credit
