Loans and lines of credit (LOC) are both ways to borrow funds from a lender. But, what’s the difference between the two?
With loans the borrower receives access to the funds only once (when the loan is closed) and makes principal and interest payments until the loan is paid in full. Loans are either secured or unsecured. Secured means the loan is backed by some form of collateral which can be repossessed if the borrower defaults on the loan. Unsecured loans are not backed by collateral and approval relies on the borrower’s credit. Unsecured loans are generally riskier and, thus, are for lower amounts at higher rates. Some common types of loans are mortgages, automobile loans, debt consolidation loans, home improvement loans, student loans and business loans.
On the other hand, with a LOC the borrower receives a set credit limit and has repeated access to the LOC while it is active making payments on the amount accessed. This makes it revolving credit which is a more flexible borrowing tool. The borrower can access the funds up to the set credit limit at any time, for any need as long as the account is up to date on payments. LOC are either secured or unsecured and tend to have higher interest rates, lower dollar amounts and smaller minimum payments compared to loans. LOC also impact consumer credit reports and credit scores more significantly then loans. Some common types of LOC are personal, business and home equity (HELOC).
When deciding which option is best for you, consider your reasons for borrowing (i.e. a one time purchase or continued borrowing for any purpose), dollar amount needed and desired monthly payment. Have more questions? Contact your local bank for help on picking the best option for you!