The main difference between a line of credit and a credit card is that you can draw cash from a line of credit for larger purchases that can be paid back over a longer time horizon, while a credit card is generally used for everyday purchases with the aim to pay off the balance each month in full.
Line of Credit
Pros
- Great way to build credit
- Low interest rate compared to a credit card
- Flexible repayment options
- Little or no restrictions on use of funds
- Minimum payment usually consists of interest charges only
Cons
- Can lead to overspending, leading to debt problems and credit score downgrades
- Variable interest rate structure means interest charges can increase over time
- May require collateral for those with poor credit
- Requires a good credit score to get a low interest rate
Credit Card
Pros
- Little or no restrictions on use of funds
- Flexible repayment options
- Great way to build credit
- Minimum monthly payment is small relative to outstanding balance
- Access to a rewards program and various perks
Cons
- Can lead to overspending, leading to debt problems and credit score downgrades
- High interest rates
- Numerous fees
- The top cards require an excellent credit score
Line of Credit Explained
A line of credit is a loan that lets you borrow money against a revolving credit line from a financial institution.
You can draw funds up to a predetermined limit and pay interest only on the amount borrowed.
A line of credit may be secured or unsecured.
To qualify for the former, you must pledge an asset as collateral.
Most lines of credit come with variable interest rates, which means the interest you pay will fluctuate based on changes in your lender’s prime rate.
How Does a Line of Credit Work?
A line of credit provides access to a revolving credit line from which you can borrow money up to your credit limit as needed.
Interest charges will accrue on the first day you draw funds and continue accumulating on the principal until you pay it off in full.
Payment terms on a line of credit are flexible – you can repay the principal at your discretion, either as a lump sum or a series of smaller payments over time.
However, at the minimum, you must apply a monthly payment that covers the interest charges.
Getting a Line of Credit
To obtain a line of credit, you’ll need to apply at a financial institution (bank, credit union, etc.) and satisfy the eligibility requirements.
These include a credit check and income verification.
Qualifying for a line of credit may be easy or difficult, depending on the strength of your credit profile and overall credit history.
Generally, most banks would be willing to approve you for a line of credit if your credit score is 650 or higher.
The financial institution will also assess your ability to manage debt responsibility and make timely payments.
Using your credit report, they’ll examine information such as:
- Your payment history
- Your credit utilization
- The size of your debt payments relative to your income
- The amount and type of debts you currently owe
A steady job is also a requirement for banking institutions, as they want assurances that you can comfortably repay what you borrow.
When to Use a Line of Credit
Lines of credit have two features that distinguish them from credit cards: a low-interest rate and generous credit limit.
As a result, a line of credit is ideal for financing a significant, one-time expense that will take a long time to pay off.
Some examples are a vehicle, home renovation, or wedding.
It also functions well as a low-cost and reliable source of emergency funds.
Credit Cards Explained
A credit card is a debt instrument that allows you to borrow money from your financial institution to make purchases.
It’s a type of revolving unsecured credit product.
Each credit card comes with a credit limit, which is the maximum amount you can borrow at any one time.
If you fail to repay your balance before your card statement’s due date, interest charges will accrue on your account.
Many credit cards offer a rewards program and perks such as travel insurance and purchase protection.
Did You Know?
Should someone conduct an unauthorized purchase using your credit card, Canadian law limits your maximum liability to $50.
How Does a Credit Card Work?
You can use a credit card to make purchases using borrowed funds up to your credit limit.
Repayment options on a credit card are flexible – you can pay off the principal in full immediately or in smaller increments over time.
However, you must contribute a minimum monthly payment to keep your account in good standing.
Like any loan, credit cards charge interest.
However, they have a unique feature known as the grace period, which is the time frame between the date your billing cycle ends and the payment due date.
If you pay off your entire balance before your grace period expires, you’ll incur no interest charges.
Getting a Credit Card
There are plenty of credit card options in Canada.
Financial institutions, like banks and credit unions, offer various credit cards, each with unique rewards programs, perks, credit limits, interest rates, and fee structures.
As with any loan, acquiring a credit card requires you to meet a series of eligibility criteria.
You’ll need to be at least 18 years old (or the age of majority in your province) and be a permanent resident or Canadian citizen.
To qualify for most credit cards, you’ll need a credit score of at least 650.
If your score falls below this threshold, you’ll face hurdles in acquiring a credit card with favourable terms and features.
In addition, your card issuer will scrutinize your credit report, examining items like your payment history, current debt load, and whether you’ve filed for bankruptcy.
They’ll also consider your income to ensure you can repay what you borrow.
When to Use a Credit Card
Credit cards are valuable tools for purchases you cannot afford to pay for immediately but can repay over a short period (less than a year).
Examples include a dining room set, Christmas gifts, and an unexpected car repair bill.
Given the steep interest rates they charge, credit cards are unsuitable for expensive items that require months or years to pay down, such as a new vehicle.
In addition, you can use a credit card for everyday and recurring purchases to earn points or miles, provided you pay off your statement balance each month.
