Loan vs. Line of Credit: An Overview

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 business lines of credit or home equity lines of credit (HELOCs); a borrowing limit is provided to a consumer who can borrow the funds again later after repayment. There are sometimes non-revolving lines of credit, but most do not have an "end date."

Loan

There are plenty of "general" differences between loans and lines of credit. Standard loans are often given for bigger-ticket debts such as a house or car and are more likely to be secured against an asset. On average, closing costs, if any, are higher for loans than for lines of credit.

After approval for a loan, you receive the full loan amount right away and usually begin accruing interest on those funds immediately. Many loans also require a specific purpose. These may include taking out a student loan to pay for higher education or being granted a mortgage to buy a property.

Line of Credit

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.

After approval for a line of credit, you can borrow up to a certain amount right away, but you will not receive a large check or money transfer up front. Interest accumulation only begins once you make a purchase or take out cash against the credit line. Lines of credit, however, do not typically have a specific purchase purpose. You can purchase a variety of items without the lender's approval.

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.

[Important: ] On average, closing costs, if any, are higher for loans than for lines of credit.

Lines of Credit vs. Credit Cards

Lines of credit are very similar to credit cards, though they are not identical. Unlike credit cards, you can secure lines of credit 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 scores by building up a credit history. In this way, the two forms of debt can be used to complement each other.

Key Takeaways:

  • Lines of credit tend to have higher rates of interest and smaller minimum payment amounts.
  • Typical loans might include mortgages, student loans, auto loans or personal loans.
  • Lines of credit are very similar to credit cards, though they are not identical.