Line of credit vs. loan: Which is best for you?


In a Nutshell

If you’re looking for financing options, you’re probably considering a loan. But a personal line of credit or a business line of credit could be a better option in a handful of circumstances. Interest doesn’t begin to accrue until you draw on a line of credit — plus you can repeatedly draw from it as often as needed as long as you remain in good standing with the lender.
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A line of credit works differently than a loan but may be a great alternative when you need funds on an ongoing basis.

Lines of credit share some common qualities with loans but offer a different way to access cash and repay balances. If you’re deciding between a line of credit and a loan, whether for your personal finances or business, those differences are important to understand.

Line of credit vs. loan at a glance

Line of credit Loan
No interest until you borrow (or “draw”) from the loan Accrues interest on the full value right away
Can repeat as often as often as needed (as long as the line is open and in good standing) Requires fixed payments over a set period of time
May be difficult to qualify with fair credit More options available across credit standings (though may come with higher interest rates)

Is a line of credit the same as a loan?

You’re probably familiar with how a loan works: Once your loan application is approved, you receive your loan money as a lump sum. You’re typically required to start making at least minimum payments and will pay interest on the money you’ve borrowed right away.

A line of credit is essentially a reusable loan. You can borrow up to a certain limit, make minimum payments, pay interest, pay off your balance, and borrow again. You can repeat this process as many times as you like as long as your line of credit is open and in good standing.

How can you use a line of credit?

You may be able to use funds from a line of credit by writing checks, using a card tied to the account, or requesting a transfer to your checking account. Even though the line gives you access to money up to a certain limit, you won’t be charged any interest until you borrow, or “draw,” from the available funds.

For unsecured lines of credit, you can only draw from the line of credit for a limited period of time, usually a few years, after which there is a repayment period in which you must pay off any remaining balance (typically, around three to five years).

Personal line of credit vs. personal loan

Accruing and paying back interest

With a personal loan, you’ll begin accruing interest on the full loan balance right away and will be responsible for making fixed payments over a set period of time. But with a line of credit, you won’t have to pay interest until you draw on the line, and you’ll only be charged interest on the outstanding balance you carry.

Access to funds

Having a line of credit means having access to funds you can use and repay over and over again within a certain time frame. This can be handy when it comes to big projects like a home remodel, where expected costs can shift. It could rid you of the hassle of having to find an extra source of cash when costs come up down the line.

Qualifying for a line of credit vs. a loan

You may find it difficult to qualify for a line of credit if you don’t have the best credit, since approval usually requires that your credit be in good condition. If your credit scores are less than stellar, you may be able to find a personal loan you qualify for — just know that lower scores could mean higher interest rates.

Other considerations

Loans may be a better alternative for a number of other reasons too. They allow you to limit what you borrow to the amount you need upfront, rather than have an open balance you can draw on. And they offer the predictability of required regular monthly payments that you can budget for.

But debt could build up for lines of credit and loans if you are tempted to make just the minimum required payments while letting interest build. So before considering either option, make sure you’ll be able to repay the funds according to the terms.

Loans vs. lines of credit: Which should you pick?

loansvslinesofcreditImage: loansvslinesofcredit

Times when you may consider applying for a personal line of credit

  • You’re not sure how much money you’ll need
  • Your expenses may be spread out over a period of years
  • Your credit is in good condition

Times when you may consider applying for a personal loan

  • You know how much you need to borrow
  • You want to limit the amount of debt you take on

Business line of credit vs. business loan

Both lines of credit and loans can be useful options when managing a business, depending on your business’s financial situation and individual needs.

A business line of credit can offer access to cash on demand and payment flexibility

A line of credit may offer some major advantages over a loan. It’s one of the ways to access cash on demand, which can be crucial to the success of a business.

Lines of credit can also offer flexibility when it comes to monthly payments. Typically, you can make the minimum payment, pay the full balance or pay an amount in between. But keep in mind that you’ll pay interest on any balance you carry.

Times when you may consider applying for a business line of credit

  • You need ongoing access to cash
  • You need payment flexibility
Can I get a line of credit with bad credit?

A business loan can potentially be more cost-effective

That said, business loans can still serve an important purpose. Loans can potentially be more cost-effective than lines of credit if you know exactly how much cash you need for a project or repair. With all your loan costs known up front, a business loan offers the ability to budget for both your total repayment cost and monthly payments. And if you make those planned payments responsibly, you can avoid allowing unexpected interest to build beyond your ability to pay.

Times when you may consider applying for a business loan

  • You know how much you need to borrow
  • You want set repayment costs
Learn about business credit scores

Next steps

Before applying for a loan or a line of credit, it’s important to consider how much financing you’ll need in the long and short term, as well as the condition of your credit, to help you make the best decision for you. There are a lot of considerations to each approach that depend on your circumstances — which also may affect the interest rate you’ll be offered or access to funds available.

Whichever option you decide to go with, having a repayment plan and knowing your budget will help you pay the funds back in the most efficient way possible without increasing your debt or adding additional interest.

About the author: Sarah C. Brady is a San Francisco–based financial consultant, workshop facilitator and writer. In addition to writing for Credit Karma, Sarah writes for Experian, LendingTree, Magnify Money, MSN News and more. In her … Read more.