Having access to credit can prove to be extremely helpful at certain points in life especially when your bank account isn’t quite adequate enough to handle life’s big expenses. Credit can also be convenient when you want to have a financial cushion to back you up if you are ever faced with a last-minute, urgent expense that you need some financial assistance with.
That’s where a line of credit or a credit card can come in super handy. The question is, what’s the difference between the two? And is one better than the other?
What is a Line of Credit?
A line of credit is an account that you are able to withdraw money from. You’ll be given a certain credit limit that you won’t be able to borrow more than. You can borrow as much or as little as you like, as long as you don’t go over this credit limit.
You’ll have the freedom to repay whatever you have borrowed right away or over a certain repayment schedule, and only the amount that you borrow is charged interest – not on your whole credit limit. Once you repay whatever you have borrowed, you are free to borrow that money again and again whenever the need for extra cash arises.
Want to know how to get the best rate for a line of credit? This article is for you.
Unsecured Lines of Credit
A line of credit that does not come backed by collateral is known as an unsecured line of credit. Without any way for the creditor to recoup their losses if you ever default, an unsecured line of credit is somewhat risky for the lender.
As such, you can expect the approval process to be a bit more stringent. You’ll need a good credit score, positive payment history, decent income, and low debt-to-income ratio. You may also be charged a slightly higher interest rate to compensate for the higher risk for the lender.
Secured Lines of Credit
Unlike unsecured lines of credit, secured lines of a credit require collateral. These are usually more attractive options for borrowers who don’t have stellar credit. They may also come with lower interest rates and more favourable terms. The risk for you is that if you default on your payments, the creditor can seize whatever asset you put up as collateral.
Who Would Benefit From a Line of Credit?
A line of credit is great for anyone who may experience cash shortages every once in a while, but they are particularly useful for the following scenarios:
Small business owners with cash flow issues. Small business owners who may experience shortages with cash flow on occasion can benefit a great deal from a line of credit. Whether customers are late on paying their invoices or they’re going through a seasonal low, cash flow shortages can hinder the operation of a business.
There are still employees to pay, the lease to cover, and vendors to pay. Having access to a line of credit can provide small business owners with immediate access to cash required without having to go through the motions of applying for a loan and waiting for approval and access to funds.
Business credit cards vs. lines of credit, check it out.
A higher credit limit is required. Compared to credit cards, lines of credit typically offer higher credit limits compared. If you need a higher credit limit, then a line of credit may be a better option than a credit card.
A less stringent repayment schedule is needed. Any money that you borrow against a line of credit can be repaid more gradually compared to credit cards. So, if you’re usually not able to repay the full amount that you withdraw every month, then a line of credit may be best.
What is a Credit Card?
A credit card is a financial tool that allows consumers to make purchases without paying for them right away, up to a certain limit. The balance owing on a credit card should technically be repaid by a specific due date every month. But, you can make what is called a minimum payment. It’s a small percentage of what you actually owe, this minimum payment can help consumer purchases goods they wouldn’t be able to afford otherwise but it can also create a cycle of debt that is hard to get out of.
Learn how to choose the right credit card for your needs here.
Similar to a line of credit, you’ll be charged interest only on the portion of the credit amount that you actually use. Anything else is not charged any interest. Interest rates associated with credit cards tend to be among the highest out of any other credit tool out there and are typically a lot higher than those associated with a line of credit.
Credit cards are great financial tools, but if you’re not very responsible with money, they can actually put you deep in debt with every billing cycle that passes.
Who Would Benefit From a Credit Card?
A credit card can prove to be very useful and is best suited for the following situations.
Getting rewards. Credit cards typically offer some sort of reward or points program. With every dollar you spend, you’ll get something in return, such as points that can be used for travel, goods, services, and other perks. Every credit card offers something different, so the one you choose should be in line with your needs and desires.
Taking advantage of 0% APR introductory periods. Many credit cards offer an introductory period in which you are not charged any interest on whatever you spend against the credit card limit. As long as you make the minimum payments every billing cycle, you won’t have to accumulate any debt on any overdue balances.
Requiring limited access to cash. A line of credit can give you access to a high credit limit, but credit cards usually don’t, depending on your creditworthiness and income. If you only need access to a limited amount of money, then a credit card can work for you.
Being able to make payments every month. Only borrowers who are financially sound and responsible enough to make payments on time every month should take out a credit card. Or else, if you miss payments or only make minimum payments every month, your debt will grow very quickly and your credit score will suffer.
Credit cards tend to come with very high-interest rates, as already mentioned, that can be as high as 30%. The more debt you accumulate, the more interest you’ll have to pay, which can make paying down your debt more difficult over time.
Want to know the difference between a personal loan and a line of credit? Check it out here.
Comparing a Line of Credit and a Credit Card
Based on the info explained, the main differences between a line of credit and a credit card include the following:
- Interest rates – Credit cards usually come with much higher interest rates than lines of credit.
Prepayment requirements – Lines of credit are not as stringent when it comes to paying back whatever was borrowed against them, while credit cards require prompt payments each month.
Credit limit – A line of credit can offer much higher credit limits than credit cards.
- Rewards – You won’t get any points or rewards with a line of credit, unlike credit cards.
Basically, a credit card is best suited for regular purchases, while a line of credit is best suited for cash advances.
What About Home Equity Lines of Credit (HELOCs)?
A home equity line of credit (HELOC) is very similar to a line of credit in that you have access to a certain amount of credit that you can borrow against. HELOCs allow you to borrow using the equity in your home, so if you have a lot of equity built up, you may be able to access quite a bit of cash.
For more information on accessing your home equity, click here.
The main difference between the two is that your HELOC is secured. Of course, you can always take out a secured line of credit, but if your line of credit is not collateralized, you may be charged a higher interest rate compared to a HELOC. On the other hand, a HELOC may not work for you if you don’t have much equity in your home or if you don’t own a home at all.
Need Some Credit?
Just about everyone could use some financial assistance from time to time, and lines of credit, credit cards, and HELOCs may be great tools to take advantage of. To help you find the right credit product for your specific situation, be sure to get in touch with Loans Canada today.