The Difference Between a Loan and a Line of Credit

When the need occurs to borrow money, many people wonder about the different types of loans and lines of credit that are available to consumers. Most people are unaware of the differences between a loan and a line of credit. There are important differences to consider when you are looking into borrowing money. The differences between the different ways of borrowing money will help you decide which method is best for each individual situation.

Loans:

Most loans are a set amount of money that you are given in a lump sum. They have a fixed repayment plan and either has a fixed or variable interest rate, depending on the terms of the individual loan. For most loans, you know what to expect your payment to be each month of the loan. Loans are often used when you have a good idea of the amount of money you will need to borrow, like when purchasing a home or a vehicle. The closing costs are often higher on a loan than for a line of credit but usually have lower interest rates.

Line of Credit:

A line of credit functions more like a credit card than a loan. With a line of credit, you are given a maximum amount of money that you can borrow over a certain period of time. As you need money, you can take advantage of and borrow that money, up to the maximum amount you have been approved for. It does not all need to be taken all at once. Just like with a credit card, you only make payments based on the amount that you have already borrowed. Often, once the money has been repaid, the money can then be borrowed again. This type of borrowing works well when you are unsure of how much money you will need or will have varying needs over time. A line of credit often has a higher interest rate than a loan, but smaller minimum payment amounts.

Requirements:

Each bank or lender will have a different set of requirements for a line of credit or loan. You will need to determine your needs and what would work best for your situation. When borrowing money, there is always a credit evaluation. You will need to have good credit or striving to have good credit to be approved for either type. Considering the different interest rates and costs associated with each different product is also an important step in deciding which product to choose for your needs. Loans usually need to be taken out for a specific purpose, but there is often not the requirement for a line of credit to state the specific purpose that the money will be used for.