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Line of Credit vs Loan: The Differences

 

When it comes to borrowing money, you might come across two terms, loans and lines of credit (LOC). Both are ways to get money and depend on your credit rating, but the difference is how you receive the funds. Loans allow you to have access to the funds once, whereas in the line of credit, you have continuous access while it’s active.

 

Choosing one or the other and knowing what’s best for you all depends on why you need to borrow. Read our article for more key differences and help to know which one is right for you, loans or lines of credit.

What Is A Loan?

Loans, also known as personal loans, are best for larger purchases where you need a bigger amount. They also have what’s called a non-revolving credit limit, which means you have a one-time sum when you apply for one, and you have to pay off the full amount once you get it.

 

Loans are also either secured, meaning it’s backed by some form of collateral, or unsecured meaning it’s not backed by collateral. For example, if you bought a car with a loan and you were unable to pay it off, the lender can take the car back and sell it if your loan was secured. If it was unsecured, there is no way for the lender to get their money back. Because of this, unsecured loans are generally for smaller amounts and higher interest rates, and secured loans have lower interest rates as most borrowers don’t want to give up the collateral.

 

Related: Understanding The Different Types Of Credit

 

There are also a few types of different loans you might find, the most common is personal loans, also known as payday loans where you can use it for anything you might need. But you can also find them as mortgages, car loans, business loans, or even student loans to fund education.

For more information, check out our types of loans available or our loans for life, from car repairs, home improvements to vet bills.

 

Pros & Cons of Loans

Pros Cons
Provides immediate access to funds as the whole amount get credited to your bank account Depending on interest rate, your total repayment can be significantly larger than the original loan
Loans can be used for various purposes Some loans require collateral, so you could lose it if you default
Comes with fixed repayment schedules to help budget & some loans allow you to pay off early to avoid interest Loans may come with additional fees such as late payment or prepayment penalties
Loans allow you to spread out large expenses over time making it more manageable Late or missed payments can negatively impact your credit sore
Secured loans often offer lower interest rates compared to lines of credit Some loans require long-term commitment if you borrow large amounts
Can improve and build credit history if you pay bills on time Taking loans out can lead to a debt cycle where you over-borrow and take out multiple loans making it hard to escape debt

 

What Is A Line Of Credit?

Lines of credit are similar to loans in the sense that you borrow money, but they work differently. Also known as credit lines, these are more like credit cards where you get a set credit limit that you can use over and over again. Credit lines have a revolving credit limit, which gives you more flexibility when borrowing and can be used for any purpose, from small purchases and everyday expenses to larger purchases.

By using a line of credit, you can access these funds whenever you need them as long as there is still credit available and you’ve paid off what you’ve used. For example, with a loan, once you borrow, that’s it. But if you have a credit line limit of £10,000 and have used £5,000, you can use the remaining balance at any time or pay off what you’ve used, then you have access to the full £10,000 again.

Credit lines do tend to have higher interest rates and lower borrowing limits than loans, but have lower interest rates compared to credit cards. Regarding credit reports, using a line of credit can impact your credit score faster and more significantly than loans do, but of course this can reflect positively if you make payments in full and on time.

You can find a few types of lines of credit on the market, including personal lines of credit where there is no collateral and usually have lower credit limits and higher interest rates, and your business and home lines of credit which are collateral.

Pros & Cons of Lines of Credit

Pros Cons
A revolving credit system where you have a limit but as you repay the credit becomes available again offering ongoing access Variable interest rates which can increase making borrowing more expensive
Allows you to borrow what you need when you need it, and you only repay what you use The access to constant funds can lead to unnecessary spending and increased debt
Only pay interest what you use, not the full credit limit There may be potential for annual fees, maintenance fees or transaction fees
Can build credit history faster and more significantly if used responsibly Credit limit can be reduced if your financial situation changes, or you miss payments
Often have lower interest rates compared to credit cards For some lines of credit collateral may be requited
Provides a safety net for unexpected expenses or cash flow shortages Missed payments or high usage can negatively impact your credit score

 

What’s Best: A Loan Or Line Of Credit

Ultimately it depends on what you need it for and personal preference, both tools are helpful for borrowing. Loans are usually best for larger, one-time fixed expenses where lines of credit are better for purchases that need flexibility and may need to use more than once. Just note that loans tend to have lower interest rates than lines of credit, but credit lines offer lower interest rates than credit cards.

Related: Is A Loan Or Credit Card Best For You?

For a summary, here’s a quick comparison chart that might help you decide to choose a loan or a line of credit.

Feature Loan Line Of Credit
Nature of Credit Non-revolving, lump sum amount borrowed upfront A revolving credit with a set limit
Repayment Fixed repayment schedule with regular instalments, option to pay early Flexible repayment, only paying back what you use
Interest Rates Interest is charged on the full amount, and it’s often fixed Interest is charged only on amount used and can be variable
Credit Access One-time access to funds, reapply for loan for more funds Ongoing access to the credit limit
Repayment Flexibility Fixed term, can be flexible with some lenders More flexible, can repay at any time and reborrow
Cost Management Costs are predictable due to fixed payments Can be unpredictable as it depends on what you use
Credit Score Impact Can build credit with timely payments and missed payments can harm Similar impact but can build credit faster and have more on an impact. But it can harm it more as well.
Loan term Fixed term for what you apply for Open-ended

 

When it comes to choosing one or the other, you need to think about what you want to borrow for and how often you want to have access to your funds. Both a loan and lines of credit consider your credit score and history to determine how much you can borrow as well as the interest rates. For more helpful information on loans and credit, check out our lending guides. Or for tips and tricks to be money savvy, our Good Vibes blog has it all from money-saving hacks to delicious budget-friendly foods.