Loans Vs. Lines Of Credit: Which One Is Best For You?
When you need or desire to purchase something that exceeds your available funds, it’s common to borrow the money from somewhere else. If you can’t get it from friends and family, the following practical solution is to apply for the funds from a bank or lender. However, most consumers don’t know that there are multiple borrowing options, including a loan or line of credit. Ultimately, the differences between these financial products help you determine which is best for your circumstances.
What Is A Loan?
A loan is a specific dollar amount provided by one person, company, or financial institution to another person or company in exchange for a promise from the borrower to pay interest and loan balance in full by the agreed-upon date. It’s a set amount of money made for one-time use. There are many different types of loans, including mortgages, personal loans, auto loans, home equity builder loans, student loans, payday loans, and installment loans. A little internet research can help you discover what’s the difference between a payday loan and installment loan or the difference between a mortgage and a home equity builder loan.
What Is A Line of Credit?
A line of credit is a form of loan in that it’s funding from one individual or entity to another. However, lines of credit are a set amount of money that can be used as frequently as the borrower needs it (or until the account is maxed out).
What’s The Difference?
While the definitions of loans versus lines of credit give you some insight into how they differ, let’s go a bit deeper into how these financial products vary.
- Frequency Of Use – The most significant difference between a loan is their frequency of use. A loan is non-revolving, meaning that you can only use the amount borrowed once. You must then pay the loan in full and apply for another one if necessary. A line of credit is revolving, meaning you can use the borrowed amount, pay down the balance, and use it as many times as you see fit.
- Borrower Need – Although personal loans can be used for any purpose, other loans are designated for a particular need. For example, a mortgage is used to buy a home, an auto loan buys cars, and student loans fund college tuition. On the other hand, you can use a line of credit to fund anything.
- Accrued Interest – The moment you receive a loan, interest starts accumulating. However, a line of credit does not accrue interest until you begin spending from the account.
- Repayment – When you accept a loan, you must start repaying the balance plus interest immediately until you complete your obligation. With a line of credit, payments aren’t required until you spend money. Also, you only pay for what you use with a line of credit instead of owing the entire balance.
Which One Should You Choose?
How do you know whether you need a loan or a line of credit? Below are two factors to consider:
- Financial Needs – The first thing to consider is why you need the money. If you’re trying to buy a house, a car, or pay for college, a loan may be the better option because you can apply for specific loans that get you larger lump sums of cash to acquire these major life investments. However, if you live paycheck to paycheck and want a financial cushion, frequently need extra money to make purchases, or deal with ongoing expenses (i.e., dental procedures, college expenses (beyond tuition), etc.), a line of credit would be ideal.
- Affordability – While having debt can be a good thing, too much debt can cause problems. Therefore, you want to select the most affordable borrowing option. For instance, a bank might offer lines of credit at 12% APR or 1% monthly interest. However, a personal loan can range from 10% to 36%. You don’t have to worry about repaying a line of credit if the balance is at zero; however, once you take the loan, you must pay the required interest rate and balance in full. If you’re trying to save money and avoid going too deep into debt, a line of credit might be a better option.
When you find yourself in a jam or simply want to make a major life purchase, applying for a loan or line of credit is often the quickest way to accomplish your goals. Hopefully, the information provided above has given you a better understanding of their differences, advantages, and common uses so you can decide which is best for you.