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What are the differences between a loan and a line of credit?

It seems that you hear the words loan and credit almost every day. When you need finance, or you lack liquidity, or need to pay large sums of money, you might think of applying for one of these two different financial products, but do you really know what the differences are between a loan and a line of credit?

Set forth below are the keys that will allow you to resolve all your doubts and select the financial product that is best for you.

Let’s start at the beginning…

A loan is a financial product in which an institution or person (the lender) grants someone (the borrower) a fixed sum of money. Meanwhile, a line of credit is a financial product that an institution makes available to one of its customers. On the face of it they would appear to be the same thing, and no doubt you are asking: what is the difference if both transactions allow me to get the money I need? The differences between a loan and a line of credit are explained below.

The kind of customer each product is aimed at.

Loans are aimed at private individuals who want to acquire goods or services (such as a car, a home, or a study course), while lines of credit are aimed at companies that have a cash flow problem. Private individuals want to pay for an investment or fund an acquisition, while businesses are trying to resolve mismatches between liabilities and receivables.

Money and interest.

When applying for a loan, the full amount is paid to the borrower when the loan is granted and the pertinent contract is executed. However, when applying for a line of credit, the money is paid to the borrower in accordance with its needs as and when they arise. As such, a line of credit is more flexible than a loan because you take what you need, within a fixed limit.

When granting a loan, the interest for the whole loan is agreed as part of the contract, while in a line of credit you only pay interest on the money that has actually been drawn down (there is a small commission for any money that is never eventually drawn down). As such, interest on a line of credit is charged at a higher rate than for a loan, but is only payable on the money that is actually used.

Repaying the money.

When it comes to repaying the money, loans are repaid by way of regular instalments within a fixed term, whereas lines of credit are repaid as and when the funds are available and this increases the sum that may be drawn down. Also, when the line of credit expires, it can be renewed directly.

Were you aware of these differences between loans and lines of credit?

You are reminded of some other posts that may be of interest to you regarding financial and economic matters, such as ‘The tax duties of communal owners’ or ‘What you should bear in mind in your tax return if you have holiday rental property’.