Comparing loans and lines of credit
A few key differences exist between a loan and a line of credit. Determining how much money you need and how long you need it as you compare your options is essential. You should also understand the benefits, drawbacks and the different repayment terms for each lending product before you make a decision.
What is a line of credit?
You can think about a line of credit as a revolving door that gives you instant access to cash. You only need to apply once for a line of credit and can have it as an option in the event of unexpected expenses, even if you don't intend to use it regularly. Similar to a credit card, your line of credit has a maximum borrowing limit, and you can withdraw any amount of money up to that maximum and use it for whatever you want.
When you borrow money from your line of credit, it is available immediately – you can transfer funds straight to your chequing account, send payments and more. You'll be charged interest on the amount you borrow starting on the day you make a withdrawal and will receive a monthly statement with your minimum repayment amount.
As soon as you repay the credit and interest, the money is immediately available to use again. The only cost of borrowing is the interest on the exact amount you use and the number of days you've used it. A line of credit is a great option because they offer much better interest rates than credit cards and allow you to repay big expenses over a more extended period.
Line of Credit
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Pros
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Cons
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Borrowers can access the funds on an as-needed basis
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Variable interest rates that fluctuate with the prime rate
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Pay for only what you use
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Possible annual or monthly maintenance fees
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Flexible repayment options
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Requires good to excellent credit to qualify
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Funds can be used for nearly any purpose. Potential to overspend.
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Potential to overspend
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What is a personal loan?
A personal loan is another borrowing option that provides you with the exact amount you need to make a big purchase in a single lump sum. A personal loan is for a specific one-time transaction, and once you take out a loan, you can’t add additional purchases or borrow more funds against it.
Unlike a line of credit with flexible repayment terms and a minimum repayment amount that will change based on how much you borrow, a loan has fixed recurring payments that are made over a set repayment term. This means each payment will be the same amount for each installment, usually due on a bi-weekly, semi-monthly or monthly basis. Knowing what your payments will be and when they are due can make managing your finances easier.
Personal Loan
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Pros
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Cons
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Interest rates and monthly payments remain fixed throughout the life of the loan. The full agreed-upon loan amount must be repaid; otherwise, you risk defaulting.
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Interest rates and monthly payments remain fixed throughout the life of the loan. The full agreed-upon loan amount must be repaid; otherwise, you risk defaulting.
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Fewer qualification requirements, such as lower minimum credit scores Borrowers pay interest on the full loan amount
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Fewer qualification requirements, such as lower minimum credit scores Borrowers pay interest on the full loan amount
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A personal loan can be used for a variety of reasons. If the loan is paid in full before the repayment term is up, the lender may assess a prepayment penalty
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A personal loan can be used for a variety of reasons. If the loan is paid in full before the repayment term is up, the lender may assess a prepayment penalty
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What are some examples of when you might use a loan vs. a line of credit?
If your borrowing needs vary and you want to make ongoing purchases, a personal line of credit is probably a better fit. A personal line of credit can be used for:
If you are interested in making a large, one-time purchase with a fixed or variable interest rate option, a personal loan may be the right option for you. A personal loan can be used for:
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Buying a car, boat or recreational vehicles
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Renovating your home
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Consolidating existing debt
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Paying for a wedding and more!
Interest rates on personal loans and lines of credit
Both personal loans and lines of credit come with interest rates. Interest is calculated as a percentage based on the dollar value of the loan. When you repay your loan or line of credit, you'll be expected to repay both the principal (the actual dollar amount you borrowed) plus interest on that amount.
Financial institutions offer two types of interest rates on personal loans:
Fixed interest rate: A fixed-rate loan means the interest rate won't change throughout the life of the loan, no matter how much the market fluctuates. This also means that your monthly payments throughout your loan term will remain the same. For example, if you buy a car with a seven-year repayment term at 3% interest, your payments will be locked in at the same amount until your loan is paid off.
Variable interest rate: Unlike fixed-rate loans, variable-rate loans (sometimes called adjustable-rate loans) do not offer a steady interest rate over the life of the loan. The fluctuations in variable interest rates are based on current market conditions and changes to prime rates set by the Bank of Canada.
This means that your interest rate will change with the market, which has pros and cons. If interest rates go down, a bigger portion of your payments will be applied towards your loan's principal, allowing you to pay it off faster. But, if rates go up, you'll pay more interest on your loan, which can take longer to pay down your principal.
Lines of credit typically have variable rates because they are open-ended and flexible, so there is no set repayment term, and the amount borrowed can fluctuate greatly. When you apply for a loan or line of credit, your financial institution will help you decide which rate is right for you if you are given an option between variable and fixed rates.
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