If you are looking to borrow funds, you can either take a Loan or take up a line of Credit. Although both are ways to borrow money and repay it over time, there are some key differences between a loan and line of credit.

A loan is a lump sum amount given to you which you repay over time in fixed instalments. A line of credit is a revolving credit option where you can borrow money up to a limit at any time, pay it back, and borrow again. Due to these differences, both these types can be suitable in specific circumstances.

In this article, we will understand the differences in lines of credit and loans in detail and try to decide which option is better for you.

What is a loan?

A loan is a credit arrangement where the lender provides funds to the borrower in one go at the beginning. The borrower has to repay the funds along with interest over a few months or years. A loan is repaid in fixed monthly payments.

Borrowers can take up loans from banks, credit unions, lending companies, and such.

Types of loan

Lenders offer several types according to their purpose, duration, processing time, etc. Here are some popular types of loans.

• Personal loan: A personal loan is taken up for personal purposes like paying for weddings, education, and new electronic gadgets.
• Business loan: A business loan is used for the benefit of a business. For instance, a loan was taken up for buying new machinery for a small business.
• Secured loan: Under a secured loan, the borrower provides a valuable asset as collateral. The collateral can be used to recover the loan if not repaid.
• Unsecured loan: A loan which does not need any collateral is called an unsecured loan.
• Others: There are several other types of loans such as payday loans, debt consolidation loans, bad credit loans, same day loans, etc.

What is a line of credit?

Under a line of credit, the lender approves a certain limit of credit for the borrower. The borrower can spend any amount up to that limit whenever needed and pay it back flexibly. The amount that you have borrowed gets deducted from the approved limit. The borrower can use this limit again and again until it is not withdrawn by the lender. Lines of credit can be a flexible way to borrow money. They can be used if you have a higher credit score. They can also be used if you have a poor credit score.

Types of credit lines

There are many types of credit lines based on their purposes. Here are the most used ones.

• Personal lines of credit: A personal line of credit is an unsecured line that can be used for any personal purpose. These lines usually have higher fixed interest rates due to high risk.
• Business credit line: This line of credit is issued to businesses to be used for business expenses whenever needed. It can be secured as well as unsecured.
• Home equity lines of credit: Home equity lines are secured credit lines linked to your house. The limit is based on the market value of your home after deducting your mortgage. As they are secured, they have lower interest rates.
• Credit card: Credit card is the most popular line of credit. The user can make purchases and expenses using a plastic card up to their pre-approved limit of credit.
• Overdraft: An overdraft can be considered a credit line. It can provide ongoing access to cover expenses.

Here are the major differences in loans and lines of credit.

Key differences between a loan and a line of credit

1. Type of credit

A personal loan is a one-time credit arrangement. The lender provides one lump sum amount upfront which has to be paid back over time in fixed instalments.

A line of credit is a revolving credit arrangement. The lender approves a fixed limit, and you can borrow funds up to that limit again and again. For instance, if your lending limit is £1000 and you make a purchase of £500, you can continue making expenses until you exhaust the limit of £1000.

2. Credit limits

A personal loan will allow you to borrow more money compared to a line of credit. As lines of credit are ongoing, lenders approve smaller amounts as credit limits.

For example, if you need a significant amount of money for say, buying a new home, you should opt for a loan. As a credit line has a smaller limit, it can be used for covering small, day-to-day expenses.

3. Repayment schedule

Loans have pre-decided repayment schedules that you must follow throughout the repayment period. The amount of repayment you will make per month is fixed. This can be called a fixed monthly payment. Even if you have the money to close the loan sooner, you will need to incur early repayment charges.

With credit lines, you can make flexible repayments. You have to pay only the minimum payments periodically, but they can be lower than loan instalments. You can repay whenever you want. Even early payments are allowed if you want to make them on an as needed basis. However, keep in mind that the longer you wait to pay, the interest keeps piling up.

4. Interest rate

If we compare loans vs lines of credit, lines of credit typically have higher interest rate. Lenders consider loans to be less risky than credit lines because they have fixed repayment liabilities. However, your actual interest rate depends on your credit history and credit score. You might find on a line of credit you’ll have a variable interest rate.

Read this blog post to find out how to calculate interest on loans.

5. Interest accrual

In the case of a personal loan, the interest begins to accrue immediately on the entire loan amount because the entire amount is paid upfront to the borrower. However, for a line of credit, one has to pay interest only on the amount used by the borrower, not on the entire credit limit. For example, if you make a purchase of £300 in a month, you will have to pay interest only on £300 and not on your credit limit of £1000.

Here’s a summary of the line of credit and loan differences discussed above.

Loan vs line of credit: a summary

Which is better: a line of credit or a loan?

A loan and a line of creditboth can be great credit options according to personal circumstances and situations. One has to consider the features of each option and select one that suits their needs the most.

When to choose a loan?

Taking a loan would be a better option when-

• You need to borrow a large sum of money right away
• You want funds for a specific purpose such as buying a car, buying a house, or paying for university.
• You prefer to pay the credit back in fixed instalments.
• You need one-time access to the borrowed funds and don’t need ongoing credit.
• You are looking for a credit option with lower interest rates.

When to choose a line of credit?

Credit lines would be a wise choice if-

• You are looking for ongoing credit to manage your regular expenses like groceries, household costs, etc.
• You are looking for a flexible credit option which you can use whenever needed.
• You are self-disciplined and would not keep the personal line debt piling up. This is a crucial point because many people fail to pay their line of credit on time. The percentage of credit card accounts with two missed payments is 13.6% higher than in December 2022.

Bottom line

The bottom line is that both loans and credit lines can be excellent credit options when used in the right circumstances. To make a wise choice, one should know the differences between a loan and a line of credit.

Consider all factors. Will you be charged a late payment fee? What happens when the repayment period begins? What’s the available credit? What are the interest charges?

A personal loan is a great option for larger funding requirements such as buying real estate. However, if you are looking for an ongoing credit option for your household expenses etc., you can go for a credit line.

Frequently asked questions

Disclaimer: The information given above is provided for reference only. This is not financial advice.

Related guides:

Secured vs Unsecured Loans

Short Term Loan vs Long Term Loan

Short Term Loans vs Payday Loans