Line of Credit vs Loan

For businesses to prosper and consumers to have buying power, credit needs to be made available at reasonable rate of interest. This benefits the economy as trade prospers on the basis of effective use of credit. There are many ways in which an individual or a business may avail credit. Credit is extended by any financial institution as it profits from the interest paid by the borrower over the principle. Though this basic nature of credit offering remains the same, the different credit types vary according to the terms and conditions of repayment and interest charged. A 'Loan' and a 'Line of Credit' are two such types of credit offerings.

Comparison Between Line of Credit and Loan

Both credit offerings including lines of credit and loans are made available by most banks and financial institutions. It is essential that one knows the difference between line of credit and loan, when choosing between the two. Let us begin this line of credit vs loan discussion by defining the two types of credit.

Basic Difference
Let us first see how a line of credit work. When a person opens a line of credit with a financial institution, he is allowed to borrow less than, or up to a credit limit at any point of time. He or she will only need to payback the interest on the amount borrowed. A line of credit is a more flexible form of credit, where there is no restriction on the amount borrowed, as long as it is below a preset limiting figure.

The repayment plan is also flexible. Line of credit is opted for, by most businesses due to their flexibility of payment and the convenience of borrowing according to need. A line of credit may be secured or unsecured depending on the borrowing limit. A line of credit is somewhat similar to a credit card in its nature. Overdraft line of credit, personal line of credit and business line of credit are some examples of this type of credit offering.

A loan is a fixed amount of money that a financial institution grants a borrower at a fixed or floating interest rate. The repayment period is preset, along with the number of installments in which the principle and interest needs to be repaid. This is the most commonly availed type of credit. When a large amount of money is needed, which needs to be paid immediately, opting for a loan is the only option. There are many types of loans and they may be secured or unsecured depending on the amount borrowed.

Distinctive Features
A line of credit is ideally suited, when you need to borrow small amounts of money in an emergency. Many people open a line of credit to prepare for unpredictable expenses that may arise. The low interest rates offered on lines of credit, along with easy repayment plans make them attractive options. Loans are the right credit type to opt for, when you are looking for a large sum of money with a long repayment period. While line of credit is a short term debt option, a loan is a long term debt option. If you compare home equity line of credit with loans, the difference is largely the convenience of paying back money, without any fixed payment schedule.

Depending on your requirement, you can either opt for line of credit or loan. Loan remains the default choice when you know how much credit you will need, and are clear about the repayment period. However, if you have a variable credit requirement, it makes sense to opt for a line of credit instead. Consult a financial advisor who can help you decide which among the two, is ideally suited for your requirement.