Line of Credit vs Loan: What's the Difference?
With a loan, the full amount is disbursed at one time and interest is incurred; with a line of credit, the money can be withdrawn over time and then interest is charged, along with payments.
When you take out a loan, you immediately accrue interest on the full balance and have to make fixed payments over a set time period. But when you open a line of credit, interest is only charged once you use some of the money, and you’ll only be charged interest on the outstanding balance, rather than on the whole line amount.
Should I open a line of credit or a loan?
Whether you need a loan or a line of credit depends on your situation and goals. A line of credit gives you access to money that you can use and repay as you need to over a certain time frame. You’ll know you have the money available should you need it for unexpected expenses or a large project like home remodeling. A loan limits what you borrow to the amount you need upfront and gives you predictable monthly payments you can budget for.
How is a line of credit different from a credit card?
In general, a line of credit is usually for a significant expense, while a credit card can be used for smaller expenses. Credit cards are easier to obtain and don’t require the paperwork a line of credit does. Both can be secured or unsecured, although credit cards that require collateral are only for people who are trying to build their credit.
The two work similarly. You use the money you need when you need it and only pay interest on what you borrow. Usually, they are revolving, meaning as you pay them back, that money becomes available to borrow again. But there are differences:
- Credit cards are almost always unsecured, but lines of credit can be either secured or unsecured.
- Credit cards can include rewards programs that lines of credit don’t. Make sure that if there’s an annual fee for your rewards card, the benefits make it worthwhile.
- Interest and lowercase rates on lines of credit are usually lower than on credit cards. And, line of credit amounts are usually higher.
- If you need cash from a credit card, you’ll pay a higher APR, but with a line of credit, you will always have cash on hand at the same rate.
Line of credit vs. loan: which is best for you?
When you take out a personal loan, you’ll immediately begin accruing interest on the full balance and you’ll have to start making payments right away. This is different from a line of credit, which only charges you interest when and if you use the money.
It can be harder to qualify for a line of credit if your credit isn’t established or strong. In that case, a loan might be a better option, but it can come with higher rates. A benefit of loans can be that the borrowing amount is limited, so you can avoid over borrowing. Plus, because you get it all upfront, you pay the money back with fixed monthly payments that fit your budget. These details mean personal loans can be good for immediate expenses when you know how much you need, and lines of credit can be great to have for unexpected expenses, or when you expect to have repeated large expenses over time.