Credit Line vs. Loan: Unraveling Essential Distinctions
Loans and lines of credit are two popular financial tools that can help manage your expenses. Both have their unique features and are suitable for different financial needs.
Loans are amounts borrowed from banks, lenders, or financial institutions for various purposes. They can be used for purchasing a home, financing a car, medical expenses, weddings, education, and more. Loans typically have longer repayment periods, providing stability with fixed interest rates, and multiple types of loans are available for various purposes.
On the other hand, a line of credit is a revolving credit facility where a bank provides a credit limit based on the borrower's credit history. It can be used whenever needed and the repayment is made by the next month's due date, with no fixed repayment schedule. Lines of credit offer a financial safety net for unexpected expenses, such as medical emergencies.
Loans and lines of credit can be classified into two broad categories: Secured and Unsecured. Under a secured loan or line of credit, valuable assets such as land, buildings, vehicles, etc., are kept as collateral for the lender. Examples of secured loans include mortgage loans, auto loans, and home loans, while secured lines of credit include overdraft facilities on FDs (Fixed deposits) and FD-backed credit cards.
In contrast, under an unsecured loan or line of credit, no asset is kept as collateral for the lender. Examples of unsecured loans include personal loans, education loans, and wedding loans, while unsecured lines of credit include overdrafts, personal lines of credit, and credit cards.
Loans are typically given at fixed interest rates and charged on the total loan amount, while a line of credit may charge variable interest on the amount used. Loans are suitable for big investments or expenses, like buying a house or a car, while lines of credit are better for smaller, ongoing or fluctuating expenses.
The advantages of using a line of credit over a personal loan for short-term financial needs include ongoing, flexible access to funds, paying interest only on the amount used rather than a lump sum, and the ability to borrow repeatedly as you repay. Lines of credit provide revolving credit, meaning once you repay borrowed money, those funds are available again without reapplying, which suits unplanned or fluctuating expenses well. They often have lower interest rates than credit cards and allow minimum payments over variable periods, reducing financial strain during tight budgets.
However, personal loans provide a lump sum with fixed interest rates and fixed monthly payments, making them preferable for larger, predictable expenses and for those who want a set payoff timeline.
Timely and consistent loan repayment has a positive impact on your credit score and helps build a healthy credit history. In the case of loans, interest accrual starts once the loan amount is disbursed in the borrower's bank account. In the case of a line of credit, interest is only charged when the borrower has used their credit limit, and it only calculates interest on the outstanding balance, not the total credit limit.
When taking out a loan, the bank charges interest on the borrowed amount, and the repayment is made in fixed monthly installments known as EMIs, consisting of both interest and principal repayment.
A good credit score is generally required for easy loan approval, but other factors, such as age, income level, and employer, are also considered before offering a loan or line of credit.
In conclusion, whether you opt for a loan or a line of credit depends on your financial needs, the purpose of the loan, and your creditworthiness. It's essential to understand the terms and conditions of each option before making a decision to ensure you make the best choice for your financial situation.
[1] "Lines of Credit vs. Personal Loans: Which Is Right for You?" Consumer Reports, 12 Mar. 2021, www.consumerreports.org/credit-cards/lines-of-credit-vs-personal-loans-which-is-right-for-you-a1392880696/
[2] "Personal Loans vs. Lines of Credit: Which Is Better for You?" NerdWallet, 2021, www.nerdwallet.com/blog/loans/personal-loans/personal-loans-vs-lines-of-credit/
[3] "Lines of Credit vs. Personal Loans: Which Is Better for You?" Bankrate, 2021, www.bankrate.com/loans/personal-loans/lines-of-credit-vs-personal-loans/
[4] "Personal Loans vs. Lines of Credit: Which Is Best for You?" Forbes Advisor, 2021, www.forbes.com/advisor/personal-loans/personal-loans-vs-lines-of-credit/
- Maintaining a good credit score is beneficial, as it can help you qualify for a better fixed deposit (FD) backed credit card and secure a bigger FD-backed line of credit.
- In personal finance, a good credit score can make it easier to secure a fixed deposit and demonstrate to lenders that you are financially responsible.
