A loan and line of credit are both ways for people to borrow money and pay it back over time. But there are differences in how you receive funds and how you pay them back. A loan gives you a lump sum of money that you repay over a period of time. A line of credit lets you borrow money up to a limit, pay it back, and borrow again.
A Loan Is For One-Time Costs
When people talk about a loan, they are usually discussing an installment loan. With an installment loan, borrowers receive the loan funds immediately, often using them to pay for a large expense like a car or house. The borrower pays off the loan in regular installments over a period of months or years. Most loans require borrowers to make the same payment each month until the loan is paid off. Once it’s paid, the loan is closed and borrowing again requires a new loan. The most common types of loans include auto loans, home mortgage loans, personal loans and student loans.
A Line Of Credit Can Be Used Over And Over
A line of credit is considered a revolving account: borrowers can borrow and pay it off again and again without applying for a new loan. For example, a credit card is a line of credit. If you make purchases up to the card’s credit limit, your available credit will be zero. Once you’ve made payments to reduce the balance, you’ll have credit available and can borrow again. You can repeat this cycle of borrowing, paying, and borrowing over and over.
Credit cards are a unique line of credit because paying the balance in full each month means you won’t pay interest. Other lines of credit may not have this grace period and you’ll be charged interest starting when you borrow the funds. Some lines of credit like a home equity line of credit have a draw period where you only pay the interest charges. When the draw period ends, there is a repayment period where you repay both interest and the amount borrowed. No matter what type of line of credit you have, you’ll need to make a minimum monthly payment. Common examples of lines of credit are credit cards, store credit accounts, home equity lines of credit, and business lines of credit.
Is A Loan Or Line Of Credit Right For Me?
- Both affect your credit score. Both a loan and a line of credit will appear on your credit report and can help build your credit if you make your payments on time. Also, a small part of your credit score is determined by your mix of credit types. Loans and lines of credit are considered different types of credit, so responsibly managing both can help your credit score.
- Both charge interest. Interest rates vary according to your credit score and the loan purpose, so you’ll want to review your options carefully.
- Both may offer secured and unsecured options. A secured loan or line of credit is backed by a lien against some type of collateral, like a property or a car. An unsecured loan or line of credit is based on your creditworthiness, not tied to collateral.
- Loans are best for large, one-time purchases. For example, the large lump sums required to purchase a new car or home are one-time expenses where the flexibility of a line of credit doesn’t matter.
- Lines of credit offer flexibility for smaller expenses. For smaller, ongoing expenses, a line of credit is a much more flexible way to borrow funds. This also means a line of credit can be a better option as a source of emergency funds. You won’t pay interest if you don’t borrow from your line of credit, but it’s there if you need it.
FAQs
For example, a loan is typically for a fixed amount for a fixed time with a prearranged repayment schedule. In contrast, a line of credit has more flexibility and usually has a variable rate of interest. When interest rates rise, your line of credit will cost more, whereas payments for a fixed loan remain the same.
What is the difference between a loan and a line of credit? ›
Personal loans and personal lines of credit serve a similar purpose but function differently. A personal loan provides a single lump sum with fixed monthly payments. Aline of credit provides ongoing access to funds but variable rates. Compare both options carefully and be on the lookout for lenders that fit your needs.
Is it better to get a personal loan or line of credit? ›
Lines of credit can be ideal for ongoing, smaller needs because you only pay interest on the funds you use. Personal loans may be a better fit for major one-time expenses, like buying a car or doing a major home renovation.
What is a line of credit with a credit union? ›
A line of credit is a preset amount of money that a financial institution like a bank or credit union has agreed to lend you. You can draw from the line of credit when you need it, up to the maximum amount. You'll pay interest on the amount you borrow.
What is cheaper a loan or line of credit? ›
Loans typically have lower interest rates than lines of credit. Because they are more of a fixed product, loans can be less risky to lenders, impacting the interest rate they are willing to lend at.
What are the disadvantages of a line of credit? ›
Cons
- With easy access to money from a line of credit, you may get into serious financial trouble. For example, if you don't control your spending.
- If interest rates rise, you may have difficulty paying back your line of credit.
Though lenders will each have their own qualification requirements when it comes to credit scores, you could get approved for a line of credit if you have a score of 660. However, your chances of approval (and getting better interest rates) increase if your score is closer to 713 and above.
What credit score is needed for personal line of credit? ›
To qualify for a personal loan, borrowers generally need a minimum credit score of 610 to 640. However, your chances of getting a loan with a low interest rate are much higher if you have a “good” or “excellent” credit score of 670 and above.
How long do you have to pay back a line of credit? ›
Unlike a personal loan, there is no set schedule to repay the money you borrow from a line of credit. However, you must make monthly interest payments on any amount you borrow, as interest begins to accrue from the very first day you borrow the money until the day you pay it back.
What credit score is good enough for a personal loan? ›
The minimum credit score needed for a personal loan is typically 580, though the best loan terms are usually reserved for people with a credit score of 640 and above. There are also ways to secure a loan with a lower credit score, and this article will break it all down for you.
Where to Get a $15,000 Loan
- SoFi® Minimum credit score. 650. APR range. 8.99% to 29.99% Loan amounts. ...
- LightStream. Minimum credit score. 660. APR range. 5.99% to 23.99% Loan amounts. ...
- LendingPoint. Minimum credit score. 600. APR range. 7.99% to 35.99% ...
- Upgrade Personal Loans. Minimum credit score. 580. APR range. 8.49% to 35.99%
Personal lines of credit are unsecured, which means you don't need to offer collateral to protect the lender if you default. That makes it different from home equity lines of credit (HELOCs), which are secured by the equity in your home.
Can a line of credit be used for anything? ›
A powerful financial tool: The money from a personal line of credit can be used for just about anything, so it can be a powerful way to pay down higher-interest debt.
Which is better a line of credit or loan? ›
A line of credit is a preset borrowing limit that can be used at any time, paid back, and borrowed again. A loan is based on the borrower's specific need, such as the purchase of a car or a home. Credit lines can be used for any purpose. On average, closing costs (if any) are higher for loans than for lines of credit.
What is the difference between line and loan? ›
A loan gives you a lump sum of money that you repay over a period of time. A line of credit lets you borrow money up to a limit, pay it back, and borrow again.
Does a credit line hurt your credit? ›
Since a credit line is treated as revolving debt, both your maximum credit line limit and your balance affect your credit utilization. Your payment history is also reflected on your credit report, which could help or hurt your score depending on how you manage the account.
What is the advantage of a line of credit over a regular loan? ›
Interest payments: Unlike a traditional (term) loan, you only pay interest on the money that you use, rather than paying interest on the overall loan amount. Flexibility: A personal line of credit usually has a long draw period, often a few years. That means you can access the money any time you need it.
Is a line of credit bad for your credit? ›
Like credit cards, a line of credit is considered revolving debt and treated similarly when generating your credit score—if you make your payments in full and on time, it will reflect positively in your credit score. In this article, you will learn: How lines of credit work. If lines of credit affect your credit score.
Is getting a line of credit a good idea? ›
A line of credit gives you ongoing access to funds that you can use and re-use as needed. You're charged interest only on the amount you use. A line of credit is ideal when your cash needs can increase suddenly, such as with home renovations or education.
Is it hard to get approved for a line of credit? ›
To land one, you'll need to present a credit score in the upper-good range — 700 or more — accompanied by a history of being punctual about paying debts. Similar to a personal loan or a credit card, an unsecured personal line of credit gets bank approval based on an applicant's ability to repay the debt.
