There are various ways businesses and individuals can borrow money from lenders. Some borrowers may be weighing loans vs. lines of credit.
What's the difference, and which is better for you? Let's take a look.
Comparing loans with lines of credit
In a loan, you generally get the funds immediately as a lump sum, and you pay that back in regular installments over several months or years. Often, people use these loans for a big one-time expense, such as buying a car or for an emergency. The most popular types include home mortgages, auto loans, student loans, and personal loans.
A line of credit, on the other hand, is considered a revolving account. When approved for a line of credit, you can borrow up to the credit limit in required quantities. The interest will accrue only on the amount of credit accessed. After paying off the previous limit along with interest, you can usually keep borrowing again and again, up to the limit.
Credit cards are one of the most common types of lines of credit. However, they're also unique in the sense that if you pay your balance in full each month, you won’t even have to pay interest on the amount borrowed. This benefit might not be available with other lines of credit, such as home equity or business lines of credit. In most lines of credit, you're required to make a minimum monthly payment. Typically, credit lines have higher interest rates than loans.
Which is better, a loan or line of credit?
What's best for you depends on why you're borrowing. For ongoing small expenses, for example, a line of credit might be better, as it's more flexible. A small business with regular expenses might find it better to dip into a business line of credit.
Also, if you're setting things up for an emergency that has yet to occur (and might not), a line of credit might be the way to go. That way, you’ll only pay interest if you need to borrow from the line of credit. Conversely, for one-time large expenses, loans might be better, as you don’t need as much flexibility.
As far as your credit score is concerned, both show up on your credit report. However, lines of credit usually have a larger, more immediate impact.
Home equity loans vs. home equity lines of credit
Whether you should opt for a home equity line of credit or loan depends on the type of expenses undertaken. A home equity loan is ideal if you require a large lump sum for a one-time expense, such as home renovation. On the other hand, a home equity line of credit may be best if your expenses will be staggered over a period of time, such as larger-scale home improvement projects that will take several months or years.