Credit Line Or Loan – What’s The Difference?

Making financial decisions of a big magnitude such as borrowing money for your personal needs or even for larger commitments, requires careful understanding of the options available. Today we are in a world that is consumer dominated and sure enough, we have various financing options available. We know that for the consumer it can sometimes be hard to figure out the various options and to decide what is right for them – that’s where this post will come in handy (we hope).

The options we are comparing today are “a credit line” and a “loan.” Clearly, to determine which one will work the best for your needs, an understanding of the difference between the two and that’s what this article is all about!

What is a typical loan?
Loans are of various kinds –from mortgages, auto loans, and student loans to personal loans. You borrow a certain amount, and then you pay it back in installments with a certain interest rate on the borrowed amount. Right from the beginning, you will know the amount you have to pay back on every installment. You can get loans of all types and sizes, with varying interest rates and durations. In general, though these terms are all fixed – a fixed sum of money, fixed payment schedules, and usually fixed tenures too.

What’s a flexible credit line?
A flexible credit line has not been as common as a loan and has generally been used by businesses or for home equity. In a flexible credit line, a borrowing limit is extended to the borrower and more money can be borrowed, usually only after that amount has been paid back. A flexible credit line normally has balance period of the principal loan account or for a stipulated time frame with revision after a certain period of time.no end date. It mostly works on the principle you have to pay back on one line of credit before you can get another line of credit. That said, the shape of the flexible credit line is set to change forever for the consumer –but more about elsewhere on this very website.

Flexible Credit Line vs a Loan
A loan is a pre-approved affair. You need the lender’s approval before you use the money you get. In most cases, the entity providing the loan will want to know what the loan will be used for and that will play a key role in the loan decision itself. A loan will also give all the money in one go, and then you will have to pay an interest on it from day one. In case of loans, you need not secure the loan against an asset but you contract to pay back the loan in installments. If you fail to do so, your credit score gets affected, which affects the approvals on your future loans.

A flexible credit line doesn’t need the lender’s approval before the money is used. In fact, here the lender doesn’t even know what are you using the borrowed money on. Here you are approved for a line of credit as against a particular purchase. In case of a line of credit, you also don’t get a lump sum of cash immediately but you have to use the line of credit for your purchases and the interest kicks in only on the amount you spend. Here the payback schedules are also more flexible in general.

A line of credit often comes with a higher interest rate, as against a fixed or floating interest rate on a particular loan. In case of the credit line, because the lender doesn’t know when will you take, spend, or fully pay back the borrowed money, they increase the interest rates. They do this to cover their added risk as also the added cost of parking a certain amount of funds on the off-chance that they will be called upon by the person utilising the credit. Also, generally a line of credit needs to be secured against a personal asset of some sort.

Some say a line of credit is a better option for funds because it is like a credit card without the minimum monthly payment clause. There are some disadvantages though. There are often higher interest rates involved in case of a flexible credit line, but you also have to pay interest only on the amount you spend. This way, you are not paying back a bigger amount like that in case of a loan. So, what if there was a way to make multiple lending agencies compete for offering consumers a flexible line of credit? Wouldn’t that competition help to bring down the rate of interest? That’s something to think about right there!

Which one is better?
Your purpose of using the money will help you decide if you need a flexible credit line or a loan. If you are buying a home, a car or another vehicle, going for a loan would make more sense because you would know the exact amount you need, and that amount won’t change after the purchase.
A loan is good for a one-time requirement. Also, in case of a loan, you are aware of the interest and the installments that you would be paying back and hence you can plan your finances accordingly and pay back the loan on time.

If you need money on an on-going basis, or if you are unsure exactly what you would need the money for just that an infusion of funds is needed, then opting for a flexible line of credit would make more sense. Also, a flexible line of credit would work well for incremental recurring monetary needs where the lender need not approve where you will spend the money. If it is flexibility you desire, then this is the mode to opt for.

Equipped with this basic knowledge, you should now be able to make an informed choice! If you need more information, we are here to help!