What Is the Difference Between a Loan and a Line of Credit?

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When you find yourself in a financial bind, borrowing money is sometimes the best solution. Friends and family are one option for getting the funds you need. Banks and other commercial lenders are also an option. When dealing with professional lenders, a loan or a line of credit are your two choices. The two are similar, but there are some important differences.

A Loan

  • According to Kiplinger, a loan is when you borrow a specific amount of money and repay the principal and interest according to a regular payment schedule. People often choose this option when they need a lump sum of money all at once, such as to buy a home or car, pay college tuition or make costly home repairs.

Loan Process

  • When you apply for a loan, you request a specific amount. Whether the lender approves your loan depends on numerous factors, including your credit history and current employment and financial situation. A lender probably won't give you a loan if you have bad credit or are unemployed.

Line of Credit

  • According to Wells Fargo, a line of credit is money you access only when you need it. When a lender approves you for a line of credit, the money goes into a special account, which you can draw on as you need it. The credit line eventually expires, and you have to repay any principal you use, including interest, within a set time frame. For example, a lender might give you a $30,000 line of credit, and you might use $10,000 to buy a new car. You then have to repay the $10,000 plus interest, but you do not have to repay the $20,000 remaining in the account unless you use it for something else.

Line of Credit Process

  • In most cases, you need collateral to apply for a line of credit. Collateral is an asset you use to secure the loan; houses and cars are common collateral items. You cannot request a specific amount of line of credit. The lender considers the worth of your assets, and then determines how much credit to extend. Usually the lender offers a line of credit equal to a percentage of the value of your collateral. The lender also considers your employment, credit history and current debt.

Considerations

  • A line of credit might be a good choice if you do not need a specific amount of money. The money is there in case of an emergency, but you do not have to use it, and you don't have to pay interest unless you use the money. A loan might be a good choice when you need a lump sum of money for a specific purpose. Unlike with a line of credit, it is possible to request a loan of a certain amount, rather than having the lender tell you how much you will get.

References

  • Photo Credit money money image by Valentin Mosichev from Fotolia.com
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