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
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.
What is the difference between a line of credit and a loan? ›
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 harder to get a loan or a line of credit? ›
Lenders often have higher credit score requirements for lines of credit compared to personal loans. For example, borrowers should aim to have a minimum credit score of 670 when applying for a line of credit.
What is the difference between a signature loan and a line of credit? ›
A personal loan is typically an installment loan, where you borrow money as a lump sum and pay it back over time with fixed monthly payments. A personal line of credit, on the other hand, is more like a credit card. You are given a set credit limit and can spend as much or as little as you like up to that limit.
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.
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.
Is credit line good or bad? ›
The Bottom Line
On one hand, excessive borrowing against a line of credit can get you into financial trouble. On the other hand, lines of credit can be cost-effective solutions to fund unexpected or major expenses.
What credit score do you need for a line of credit? ›
Opening a personal LOC usually requires a credit history of no defaults, a credit score of 670 or higher, and reliable income.
Does a credit line hurt your credit? ›
Increasing your credit limit won't necessarily hurt your credit score. In fact, you might improve your credit score. How you utilize the credit access line after the increase is one of the multiple factors that can impact your score.
How much can you borrow on a line of credit? ›
A line of credit works like a credit card. You receive a set credit limit and your borrow money as you need. You can get a line of credit in a wide range of amounts, whether you need $1,000 or $100,000 or more. This is different from a loan, where you receive a lump sum all at once and pay it back over time.
Loans and lines of credit are both types of bank-issued debt that serve different needs; approval depends on a borrower's credit score, financial history, and relationship with the lender.
What credit score do you need for a signature loan? ›
You generally need a credit score of 580 or higher to qualify for a personal loan.
Do you pay interest on a line of credit? ›
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 better to get a line of credit or a personal loan? ›
A personal loan may have a lower interest rate than a personal line of credit, making it less expensive. Rates on personal lines of credit can be variable, which means the interest rate could increase over time.
Can I withdraw cash from my line of credit? ›
The borrower can withdraw funds as needed, repay them, and then draw again, making it a revolving form of credit. There are two primary types of lines of credit: secured and unsecured. A secured line of credit is backed by assets, such as real estate or inventory, which serve as collateral.
Can someone with bad credit get a line of credit? ›
You might be able to get a personal line of credit with bad credit, but it'll be tough. Lenders usually reserve lines of credit for borrowers with FICO scores of at least 680 (sometimes higher).
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.
Why would you use a line of credit? ›
A line of credit allows you to use the funds you need, up to the agreed-upon limit. Depending on the lender's terms, you will only have to pay either the current interest on the loan each month or a predetermined percentage of your balance. You can then pay off your balance at a pace you find comfortable.
What is the minimum credit score for a line of credit? ›
The Bottom Line
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.
