Loan vs. Line of Credit: An Overview
Both business and individuals can borrow from lenders in two different ways – through loans and line of credit.
Approval for both loans and lines of credit are measured on their intended purpose, a borrower’s credit rating and financial history, along with their relationship with the lender.
Loans have what’s called a non-revolving credit limit, which means the borrower only has access to the amount loaned once, where they subsequently make principal and interest payments until the debt is paid off. A line of credit, on the other hand, works differently.
The borrower receives a set credit limit—just like with a credit card—and makes regular payments composed of both a principal and interest portion to pay it off.
But unlike a loan, the borrower has continuous access to the funds and can repeatedly access it while it is active.
- Loans and lines of credit are types of bank-issued debt that depend on a borrower’s needs, credit score, and relationship with the lender.
- Loans are non-revolving lump-sum credit facilities that are normally used for a specific purpose by the borrower.
- Lines of credit are revolving credit lines that can be used repeatedly for everyday purchases or emergencies in either the full limit amount or in smaller amounts.
A loan comes with a specific amount based on the borrower’s need and creditworthiness.
Like other non-revolving credit products, a loan is granted as a lump-sum for one-time use, so the credit advanced can’t be used over and over again like a credit card.
Loans can come in two general forms: either secured or unsecured. Secured loans are backed by some form of collateral—in most cases, this is the same asset for which the loan is advanced. For instance, a car loan is secured by the vehicle. If the borrower doesn’t fulfill their financial obligation and defaults on the loan, the lender can repossess the collateral, sell it, and put it toward the remaining loan balance. If there’s an outstanding amount, the lender may be able to pursue the borrower for the rest.
Unsecured loans, on the other hand, are not backed by any form of collateral. In most cases, approval for these loans relies solely on a borrower’s credit history and is generally advanced for lower amounts, and with higher interest rates, than secured loans.
Interest rates thus tend to vary based on the type of loan granted. Secured loans