Line of Credit vs. Loans: 3 Differences You Need to Know
December 2, 2019 by Daniel Azzoli
You might have a vague understanding of what a line of credit is vs. a loan, but when you’re in a financial bind and looking for help, it’s important to understand the distinction between the different types of loans out there. Is a line of credit a loan? Yes, but there are some noteworthy distinctions between a line of credit vs loans like installment loans or other short term loans online.
Maybe you already know that they both let you borrow money which you’ll then have to pay back with interest and/or fees, but let’s dig into more of the details so you get a better idea of the full picture.
Lines of Credit vs. Loans: Similarities and Differences
So, what’s the difference between lines of credit and loans? While we’ve established that a line of credit is considered a loan, there are still some distinctions between them and other loans. Some of the main differences lie in how the funds are paid out, the interest rates, and the repayment process.
Let’s define the two in a little more detail. A loan is often given to you in a lump sum by a financial institution, and then you’ll generally need to repay that loan with interest and/or fees over a series of scheduled payments. You may find yourself in need of an installment loan when you don’t have the money to make a big purchase, like if you’re looking to buy a house or a car. In these cases, you might take out a mortgage or an auto loan. Certain types of installment loans may also be used in situations where you run into an unexpected emergency expense and can’t cover it with your savings.
Comparatively, a line of credit is revolving, meaning you can borrow money against your available credit limit, pay off what you owe, and then borrow money again, as long as your payments are made on time. Credit cards are another common example of revolving credit.
While we’ve mentioned some differences between the two, there are also some similarities. Both forms of credit are either secured or unsecured loans, and they often have a similar application process.
Similarities of Lines of Credit vs. Loans
Let’s take a look at these similarities in more detail by going over what a secured and unsecured loan is, and the similarities in the application processes.
1. The Application Process
While the application process may vary from lender to lender, applying for a personal loan and a line of credit is often similar. In both cases, there will generally be a review of your income and your credit history, as well as a number of other factors. For example, to qualify for a loan or line of credit with MoneyKey, you must:
- Be of legal age to contract in your state
- Be a US citizen or permanent resident
- Be a resident in the state where our product is offered
- Have an active bank account
- Have a regular source of income
- Have a valid contact number and an active email address
Whether you’re applying for a personal loan or online line of credit loans, the requirements are mostly the same. Generally, one of the differences between applying for a loan from an online lender as opposed to applying with other financial institutions, like a bank, is that a prime credit score may not be required. If you meet the above criteria, you may qualify for a personal loan or line of credit with MoneyKey.
2. Secured vs. Unsecured
In the case of a loan, like a line of credit, and other personal loans, they will generally be either secured or unsecured.
With a secured loan, you’ll have to put up an asset as collateral, like your home or car. The purpose of the collateral is to ensure that if you don’t repay your loan, the financial institution will still receive payment in the form of the asset you’ve put up.
In the case of an unsecured loan, you won’t need to put up any assets to be approved for the loan. Instead, the lender will assess you as a borrower based on your credit score, which is meant to give them an idea of your history as a borrower. These loans often come with higher interest rates than secured loans. While you won’t need to put up any assets as collateral, you’ll still need to make sure you’re making your payments on time to avoid accruing more interest and other consequences.
Differences Between Lines of Credit vs. Loans
Now that we’ve gone over some of the similarities, let’s look at some of the differences, like how funds are paid out, interest rates, and the repayment process.
1. How You Receive Your Loan
One big difference between a personal loan and line of credit is how the funds are paid out. With a personal loan, your funds are generally paid out in a single lump sum. The size of these loans can vary, but lenders will often have a minimum loan amount. For example, the smallest loan amount for an installment loan with MoneyKey is $150.
With a line of credit, you’ll be able to draw money against your approved limit. This means you won’t need to borrow the approved credit amount all at once, and you can use exactly what you need as long as you have available credit or your line of credit is paid off and it’s within your limit.
While the application process of a line of credit and personal loan may be similar, the repayment process has some noteworthy differences. With a personal loan – like an installment loan for example – you’ll be given a lump sum and then be required to pay back the money you borrowed with interest and/or fees in a series of fixed, scheduled payments that span a pre-determined amount of time.
Things work a little differently for a line of credit. You may not be paying back in fixed payment amounts, and as long as you’re making all of your minimum payments on time, you don’t need to pay off what you owe in its entirety by a specific date. It’s important to remember that, while you can continue to make minimum payments, the longer it takes you to pay back what you owe, the more interest will build up.
3. Interest and Fees
With a personal loan, the payments that you’re making every month generally consist of your principal balance (which is the money that you initially borrowed) and interest and/or fees.
Like we mentioned earlier, a line of credit is revolving. This means you can borrow as little or as much as you need up to your available limit, and you’ll typically only pay interest and fees on the amount you borrow, not on your total limit.
For example, let’s say you pop a tire on your car and need to get it fixed asap, or risk missing time at work. The repair will cost $100 but the smallest installment loan available to you is $300. Instead of applying for an installment loan and paying interest and fees on the $300, if you have a line of credit available to you, you can borrow the exact amount you need – no more, no less.
Lines of Credit vs. Loans: What’s Best for You?
If you were asking, “what is a line of credit and how is it different from other personal loans?” we hope we’ve helped answer that question for you!
To summarize, some the similarities between the two lies in the application process and the unsecured/secured nature of both. The differences involve how you receive the funds, the repayment process, and the interest rates.
If you’ve run into an unexpected financial emergency and don’t have the funds to cover it, online loans may be able to help you out. Check out MoneyKey’s online loan services to learn about whether a line of credit or installment loan is right for you!