Both loans and Lines of Credit (LOC) are financial sources. They allow individual clients and businesses to withdraw money for making essential purchases or ventures. They encompass personal loans, credit cards, home loans, business loans, credit cards, and mortgages.
So, which one of the two is better for me? For this, you need to know how a loan differs from the line of credit? Well, the major difference is how you get the cash and how you then repay it. Let’s explore the differences in this post so that you can choose the best financial source.
Loans versus LOC: In Terms of Meaning
Regarded as an installment account, a loan means requesting an amount, which is received only after approval. However, you then start paying the rate of interest on the full amount per annum. A fixed term is preset for payments, which then decreases as the loan is repaid.
An LOC in the financial world is a revolving account from which you borrow up to a certain limit and then pay it back. On the other hand, a loan is a lump sum amount that is paid back over a fixed period.
The former is similar to a credit card, as it is a flexible source for borrowers. A borrower only needs to withdraw money via a cheque. After repaying the borrowed sum of your credit line, the borrower can withdraw again. Until you use the line, there is no need to pay.
Possessing a credit line makes sure that a borrower can access funds and pay the borrowed sum back within a fixed period.
Loans versus LOC: In Terms of Interest Rates
Loans, regardless of the type and lender, tend to have a fixed rate of interest across its full term. For example, if you have taken a loan for bad credit at an interest rate of 6%, this rate remains fixed throughout the loan’s tenure. Unlike loans, the various lines of credit are likely to have different interest rates.
In case of a loan, the interest starts accruing on the full loan amount. If the loan is approved and you accept it, an origination fee is likely to be levied. It is a percentage of the total amount that is deducted from the cash you obtain or added to the repaid amount.
However, when it comes to lines of credit, the interest is charged on the unpaid balance until you borrow on the line. It is likely to be higher than the interest rate on loans.
Loans versus LOC: In Terms of Application
Loans are ideal if you wish to make a big, one-time deal or purchase. For example, it is better to take a loan for buying a new home or car, starting a new business or going for further education.
On the other hand, lines of credit are ideal if you wish to withdraw a small amount or are likely to come across unexpected expenses. For example, if you need to buy a device such as a laptop that you need to use but do not have sufficient cash, then you should buy it using a credit card.
As a loan is a lump sum amount with unchangeable terms of repayment, it is ideal to go for it when you know how much you want for the targeted need and what is the budget set for that need.
A line of credit allows selecting how much and when to withdraw. It gives access to cash when required instead of reapplying for another loan.
So, which is better? Well, the deciding factor is your need. It depends whether you are looking for a small or a big amount for a short- or long-term. It also depends on your ability to repay within the stipulated time frame.