What are the exact differences between a line of credit and a loan? Read to know the distinction.
For businesses to prosper and consumers to have buying power, credit needs to be made available at a reasonable rate of interest. This benefits the economy, as trade prospers on the basis of effective use of credit. There are many ways in which an individual or a business may avail credit.
It is extended by any financial institution as it profits from the interest paid by the borrower, over the principal. Though this basic nature of a credit offering remains the same, the different credit types vary according to terms and conditions of repayment and interest charged. A ‘Loan’ and a ‘Line of Credit’ are two such types of credit offerings.
Both these options are made available by most banks and financial institutions. It is essential that one knows the difference between the two, when choosing.
When a person opens a line of credit with a financial institution, he is allowed to borrow less than, or up to a credit limit at any point of time. He or she will only need to pay back the interest on the amount borrowed. It is a flexible form of credit, where there is no restriction on the amount borrowed, as long as it is below a preset limiting figure.
The repayment plan is also flexible. This type of credit is opted for, by most businesses due to their flexibility of payment and the convenience of borrowing according to need. A line of credit may be secured or unsecured, depending on the borrowing limit. It is somewhat similar to a credit card in its nature. Overdraft, personal, and business lines of credit are some examples.
A loan is a fixed amount of money that a financial institution grants a borrower, at a fixed or floating interest rate. The repayment period is preset, along with the number of installments in which the principal and interest needs to be repaid. This is the most commonly availed type of credit. When a large amount of money is needed, which needs to be paid immediately, opting for it is the only option. There are many types of loans and they may be secured or unsecured, depending on the amount borrowed.
Prime Distinctive Features
A line of credit is ideally suited, when you need to borrow small amounts of money in an emergency. Many people open one to prepare for unpredictable expenses that may arise. The low interest rates offered on them, along with easy repayment plans make them attractive options.
Loans are the right credit type to opt for, when you are looking for a large sum of money with a long repayment period. While line of credit is a short-term, a loan is a long-term debt option.
Depending on your requirement, you may opt for either of the two. Loan remains the default choice when you know how much credit you will need, and are clear about the repayment period. However, if you have a variable credit requirement, it makes sense to opt for a line of credit instead.