What is the difference between a loan and a line of credit?

Standard loans and lines of credit represent two different methods of borrowing money for both businesses and individuals. Typical loans might include mortgages, student loans, auto loans or personal loans; these are one-time, lump-sum extensions of credit that tend to be paid down through periodic, consistent installments. Lines of credit are usually seen with business lines of credit or home equity lines of credit (HELOCs); a borrowing limit is extended to a consumer, and funds can be borrowed again later after the money is repaid. There are sometimes non-revolving lines of credit, but most do not have an "end date."

There are plenty of "general" differences between loans and lines of credit. Bigger-ticket debts such as a house or car tend to be made through standard loans. Standard loans are more likely to be secured against an asset. Lines of credit tend to have higher rates of interest and smaller minimum payment amounts. Lines of credit usually create more immediate, larger impacts on consumer credit reports and credit scores. Closing costs, if any, are higher for loans than lines of credit on average.

Two major differences between these two borrowing methods involve the "when" and the "what for." If you are approved for a loan, you receive the full loan amount right away and usually begin accruing interest on those funds immediately. If you are approved for a line of credit, you receive the ability to borrow up to a certain amount right away, but you are not going to receive a large check or money transfer up front. Interest accumulation only begins once you actually make a purchase against the credit line. Many loans also require a specific purpose; for instance, you take out a student loan to pay for higher education, you are granted a mortgage to buy a property, etc. Lines of credit, however, do not typically have a specific purchase purpose. Purchases can be made on a variety of items without the lender's approval, and no assets have to be appraised.

In this way, lines of credit represent a much more flexible borrowing tool. Payments also tend to be much more flexible for lines of credit, since the amounts and dates of purchase are uncertain. This uncertainty is offset by higher rates of interest and, sometimes, higher lending standards; it is very difficult to obtain an unsecured line of credit for any substantial amount.

Lines of credit act very similarly to credit cards, though they are not identical. Unlike credit cards, lines of credit can be secured with real assets such as a home. While credit cards always have minimum monthly payments based on a percentage of current credit balances, lines of credit do not necessarily include monthly payment requirements. Some individuals even take out personal installment loans to pay off lines of credit as a way to build their credit score. In this way, the two forms of debt can be used to complement each other.

For related reading, see What are the Differences Between a Home Equity Line of Credit (HELOC) and a Home Equity Loan?