– Credit VS Loan
In this era of rising expenditures, people are turning more and more towards borrowing instruments for aid. Financial institutions are now catering to these by providing benefits and incentives like affordable interest rates, longer repayment tenures, lower equated monthly instalments (EMIs), faster disbursal of amount, instant approvals, online applications and approvals, etc. The spend now pay later motto is becoming the trend.- Credit VS Loan
Hence, financial institutions have different credit options for businesses and individuals, whether they want to borrow for a specific purpose or an emergency backup option. Also, depending on the preferences such as the tenure of the loan, the amount, the repayment conditions, etc., different credit options are available in the market.
Line of Credit vs loan
A line of credit is a financial instrument that allows borrowing on a rotational basis. In this, the borrower requests a particular amount of credit but can withdraw any amount as and when needed from it. The interest is charged on the amount used and not the whole credit limit, and the interest rate is flexible. Repayments can be made on an immediate basis and over a predefined period. The credit amount replenishes itself every time payments are made towards the account.
The payments made towards the credit account line usually consist of the principal amount and the interest charged.
Line of credit can be of two types- secured line of credit and unsecured line of credit. A secured line of credit has to be backed by assets of the borrower, which may be seized or liquidated in case of defaulting on the payment by the borrower. An unsecured one poses a great deal of risk to the lender. If the borrower defaults, there is no liquid asset to recoup any losses.
Hence, an unsecured line of credit is accompanied by higher interest rates, a lesser credit limit, and a shorter repayment tenure than a secured one to minimise the lender’s losses.
Approval of a line of credit, be it for an individual or a business, are subject to eligibility checks. The borrower’s credit ratings, financial history, relationship with the bank, and asset value (in case of a secured line of credit) play a vital role in approving the line of credit.
A credit card is like an unsecured line of credit. In contrast, a home equity line of credit is a secured line of credit, wherein the equity in a home serves as the collateral.
A loan is a financial instrument wherein a fixed amount is disbursed as a one-time payment and can be used only once, unlike a line of credit. In this, a borrower applies for an amount of credit, usually for a particular purpose, and is charged on the whole amount. The interest rate charged is either fixed or floating, depending on the contract agreed upon by the lender and the borrower.
Usually, a loan is repaid in equal instalments over a specified period. Loans can be both secured and unsecured. A secured loan is where the borrowed amount is backed by a financial asset that the borrower owns, and most often, it is the asset for which the loan is availed on. For instance, a home loan is a secured loan. The house for which the loan is taken serves as the collateral until the loan is paid back in full.
Unsecured loans are loans that have no assets pledged to back them. Hence, in case of default, the lender cannot recover their losses. An unsecured loan, similar to an unsecured line of credit, has higher interest rates, a shorter repayment period, and are approved for lesser amounts. These loans are solely approved based on the borrower’s credit ratings and financial history.
Personal loan are kinds of unsecured loans in which the borrower avails the credit for personal expenses. Personal loan interest rates are usually higher than secured loans as there is no asset the lender can fall back on in case of a default.
Line of Credit or Loan- which should you opt for?
A loan should be preferred to finance an investment that requires a one-time lump sum amount. A line of credit is advantageous when unanticipated, small, and ongoing expenses. Line of credit also comes in handy to even out income and cash flow.
Also, in the case of a line of credit, the interest rate is floating. Hence, interest payments can not be pre-estimated. In contrast, many loans have a fixed interest rate. Hence, the total expenditure can be calculated before taking up the loan.