The main difference between a loan and a line of credit is that a loan provides you with a lump sum of money upfront, whereas a line of credit provides you with revolving access to funds you can continuously borrow and payback, up to a pre-set limit.
You can use the borrowed funds from either source for various purposes, such as financing a new vehicle purchase, consolidating high-interest debt, or paying for a home renovation.
This article focuses on personal loans and personal lines of credit, which are the most common types of consumer loan products available.
Key Differences Between a Loan and Line of Credit
On the surface, a loan and line of credit seem indistinguishable from one another.
However, there are notable differences between the two loan products, as noted in the table below.
|Loan||Line of Credit|
|Type of credit product||Non-revolving
The borrower has access to a single lump sum principal upfront at a specific date.
The borrower can draw funds up to their credit limit at their discretion, repay the principal and borrow again indefinitely.
|Interest rate structure||Fixed and variables rates available; interest accrues on the principal immediately||Variable rates are primarily available; interest accrues only on the amount borrowed|
|Repayment terms||Payments are required at regular intervals with each composed of principal and interest||Payment is required at regular intervals but may be composed of interest only initially; some lenders may offer flexible repayment terms|
Did You Know?
Interest on a loan or line of credit is tax-deductible if you use the funds to invest in an asset that produces income.
What is a Loan?
A loan is a non-revolving credit product where a lender provides you with a specific sum of money upfront.
You must repay the loan over a predetermined period plus any interest charges.
You can use the money you receive for any purpose.
However, certain forms of financing stipulate that you must use the funds for a specific purchase, such as for a car.
Most loans require the payment of principal and interest in equal installments over a defined time frame.
For this reason, they’re often referred to as installment loans.
Usually, most loan terms span six months to five years, with auto loans going up to seven or eight years, and the amount you can borrow ranges from $100 – $50,000.
Loans can be secured or unsecured.
The former requires that you pledge a personal asset as collateral for the loan, which acts to protect the lender should you default.
The latter doesn’t require any collateral; it’s backed only by your general creditworthiness.
You can obtain a loan from various financial institutions: banks, credit unions, alternative lenders, and private individuals that operate on P2P lending platforms.
To qualify for a loan, you need to pass lenders’ eligibility criteria, which usually consists of a credit check and income verification.
They may also evaluate your other debt obligations and expenses to gauge your ability to repay the loan.
What is a Line of Credit?
A line of credit is a revolving debt product where your lender provides you with access to a credit line from which you can borrow funds when you need them.
You can draw funds up to a predetermined limit, which your lender sets based on your credit score, income, and other factors.
Lines of credit are best suited for covering sporadic and ongoing expenditures where costs can vary widely.
They’re also helpful in emergencies that require cash immediately.
As with a loan, a line of credit charges interest, but only on the amount borrowed rather than the total credit limit.
You can reuse the funds whenever you repay the principal, much like a credit card.
Unlike an installment loan, you don’t need to re-apply for funding again – you can borrow money continuously when needed.
Your repayment schedule can vary depending on your lender’s policy.
Since a line of credit is an open-ended loan product, you may enjoy the privilege of a flexible payment schedule, paying as much as you choose at your discretion.
However, in most cases, lenders require you to contribute at least a minimum payment each month to settle the interest charges on your account.
Most lines of credit come with a variable interest rate.
This means that your interest charges will fluctuate based on changes in your lender’s prime rate.
If the prime rate increases, you’ll be subject to higher interest on your line of credit and vice versa.
A line of credit can allow you to borrow anywhere from $100 to $50,000.
As with most loans, a line of credit can be secured or unsecured.
If you opt for a secured loan, your lender will offer you a lower rate since they assume less risk when you back the principal with a personal asset.
Lines of credit are available from banks, credit unions, and various lenders in the alternative lending market.
To open a line of credit account, you’ll need to satisfy lenders’ qualification requirements, which include a good credit score, confirmation of a steady income stream, and reasonable debt-to-income ratio.
Though interest rates on lines of credit are normally variable, some financial institutions such as TD offer fixed-rate options.
Frequently Asked Questions
- Is a line of credit same as a loan?
No, a line of credit and loan operate in distinct ways.
A line of credit enables you to borrow funds up to a specific limit imposed by your lender. You must then repay the principal along with the interest that accrues. Any principal amount repaid is available for you to use in the future.
With a loan, your lender provides you a predetermined principal amount and you’re obligated to repay in equal installments with interest. Once you repay the loan in full, you longer have access to the funds.
- What is easier to get a loan or line of credit?
In general, you’ll face fewer challenges obtaining a loan compared to a line of credit.
The reason is that with a line of credit, you can borrow funds over a much longer time frame. You may also have flexible repayment terms and have the option to defer payment of the principal for an extended period.
These attributes increase the risk for the lender since a lengthy repayment period exposes the lender to more risk. As a result, they may place more stringent eligibility requirements on a line of credit.
- What is one benefit of taking a line of credit vs a personal loan?
One of the primary benefits of a line of credit over a loan is its flexibility. You have the freedom to draw funds only when you need them and can choose any amount so long as you don’t exceed your credit limit.
Conversely, you receive all the funds upfront with a loan, and interest accumulates on the account from the beginning. You must repay the entire principal, even if you use only a portion.
A line of credit usually comes with a lenient and accommodating repayment schedule. Alternatively, you must commit to a strict payment schedule if you’ve opted for a loan.