Lines of Credit vs. Loans – Which One Is Right For You?
Lines of credit (LOC) and loans are two different financial products that allow you to borrow money from banks or other financial institutions. Just like any other financial product, both LOCs and loans have specific pros and cons that need to be considered before any commitment is made.
Depending on the state of your finances and your financial goals, one option might be more suitable for you than the other.
In this blog, we’re going to discuss what LOCs and loans are. We’re also going to go through the advantages and disadvantages of these options.
Hopefully, this brief guide will give you a better idea of which product is best for you, your family, or your business.
What Is A Line of Credit?
A line of credit, or an LOC, is a revolving, flexible loan that allows you to repeatedly borrow money up to a set credit limit. Once you repay what you owe, you can borrow money up to that same credit limit again. Generally, types of credit lines include personal, business, and home equity.
One of the main advantages of LOCs is the financial flexibility that it provides you. With an LOC, you will be able to borrow money at any time up to your set credit limit. You can also choose to repay your debt immediately or repay it over a set period of time via regular minimum payments. Additionally, interest is only charged on an LOC when you use the money.
However, the interest rates tend to be higher when compared to most loans. Additionally, the credit limit tends to be lower with LOCs. This is because most LOCs have no collateral backing and are therefore considered unsecured loans.
If you’re not careful with unsecured loans, you might end up borrowing more money that you can afford.
What Are LOCs Used For?
LOCs can be used on practically anything. However, due to the high interest rates, they are more suited for relatively smaller expenses like utility bills, renovation projects, or tuition fees.
Lines of credit are a great way to provide financial relief if you’re low on funds on any given day. Unlike other loans, LOCs allow you to choose how much you borrow at any given time. This way, you don’t have to commit to a large lump sum of money right away.
What Is A Loan?
A loan is when you get one lump sum of money to spend on a particular investment. Since it’s non-revolving, once the loan amount is used, it cannot be used again.
Additionally, once you get a loan, you will immediately accrue interest Some loans are secured, meaning it has a collateral backing it. In most cases, these loans are secured by a vehicle or a property. If you happen to default on a loan, the lender can take possession of the collateral and sell it in order to get the money back that they’ve lent you.
Because of this assurance, the loan amount for secured loans tends to be much larger compared to LOCs. In addition, the interest rate tends to be much lower. This makes loans ideal for larger purchases like a new vehicle or a new property.
That being said, the application process for a loan is typically much more comprehensive compared to LOCs. This is because the lender wants to make sure that you will be able to repay the large loan amount in the given period of time.
What Are Loans Used For?
Due to the large loan amount, borrowers often reserve secured loans for important investments like transportation and a place of residence. Loans can also be used for home improvements, student fees, or business operations.
In some cases, personal loans (another type of unsecured loan) can also be used for medical bills, late utility payments, and other unexpected expenses.
Defaulting on a loan can have significant financial and legal consequences and shouldn’t be taken lightly. Because of this, financial advisors often discourage borrowers from taking out a loan for non-urgent or unnecessary expenses like vacations and extravagant weddings.
Hopefully, this short guide has helped you gain a better understanding of loans and LOCs. If you’re looking to make a significant financial commitment, we recommend hiring reputable financial advisors. Home loan brokers, accountants, and other fiduciaries should be able to help you make sound financial decisions.