A line of credit works differently from a loan, but it can be an excellent alternative when you need funds on an ongoing basis.
You are probably familiar with how a loan works: once your loan application is approved, you receive the money from your loan as a lump sum. Usually, you are required to start making at least minimum payments and pay interest on the money you borrowed immediately.
Credit lines share some common qualities with loans, but offer a different way to access cash and repay balances. If you are deciding between a line of credit and a loan, whether for your personal finances or your business, it is important to understand those differences.
Personal credit line vs. personal loan
With a personal loan, you will begin accruing interest on the total loan balance immediately and will be responsible for making fixed payments for a certain period of time. However, with a line of credit, you will not have to pay interest until you draw the line, and you will only be charged interest on the outstanding balance you have.
Having a line of credit means having access to the funds you can use and paying again and again within a certain period. This can be useful when it comes to large projects such as home remodeling, where expected costs can change. It could rid you of the trouble of having to find an additional source of cash when costs rise on the line.
However, you may find it difficult to qualify for a line of credit if you do not have the best credit, since approval generally requires that your credit be in good condition. If your credit is less than stellar, you may be able to find a personal loan for which you qualify, just keep in mind that a lower score could mean higher interest rates.
Loans can also be a better alternative for other reasons. They allow you to limit what you borrow to the amount you need in advance, instead of having an available balance that you can use. And they offer the predictability of the required regular monthly payments that you can budget.
But debt could accumulate for lines of credit and loans if you are tempted to make only the minimum payments required and at the same time allow interest to accrue. Then, before considering any of the options, make sure you can reimburse the funds responsibly.
Situations in which you may consider requesting a personal credit line
You are not sure how much money you will need.
Your expenses may extend over a period of years
Your credit is in good condition.
Moments when you can consider applying for a personal loan
You know how much you need to borrow
You want to limit the amount of debt you take
Business vs. Credit Line business loan
Both lines of credit and loans can be useful options for managing a business, depending on the financial situation of your business and individual needs.
However, a line of credit can offer some important advantages over a loan. It is one of the ways to access cash on demand, which can be crucial to the success of a business.
Credit lines can also offer flexibility when it comes to monthly payments. You can usually make the minimum payment, pay the total balance or pay an intermediate amount. But keep in mind that you will pay interest on the balance you have.
But commercial loans can still serve an important purpose. Loans can be potentially more profitable than lines of credit if you know exactly how much cash you need for a project or repair. With all the costs of your loan known in advance, a commercial loan offers the possibility of budgeting both the total repayment cost and the monthly payments. And if you make those planned payments responsibly, you can prevent unexpected interest from being generated beyond your ability to pay.
Moments when you may consider requesting a commercial credit line
You need continuous access to cash
You need payment flexibility
Moments when you can consider applying for a commercial loan
You know how much you need to borrow
You want to set the reimbursement costs
“If you get a loan when you really need a line of credit, or vice versa, you may end up paying more than necessary,” says Detweiler. “That’s because you can pay interest on the money you don’t use, or you may have a higher interest rate than you could have otherwise qualified.”
Before applying for a loan or a line of credit, it is important to consider how much financing you will need in the long and short term, as well as the condition of your credit, to help you make the best decision for you.