Loan vs Line of Credit: Detailed Comparison with Examples
Understanding the difference between loan and line of credit is important for students preparing for Commerce exams, competitive tests, or anyone seeking practical financial knowledge. These two common financial products are used for various borrowing needs in business and daily life. This topic helps clarify their features, real-life uses, and relevance for exam questions and smart borrowing.
| Basis | Loan | Line of Credit |
|---|---|---|
| Amount | One-time, fixed lump sum | Flexible, up to a pre-set limit |
| Usage | Single purpose (e.g., home, car) | Multiple/ongoing needs |
| Withdrawals | Withdraw all at once | Withdraw, repay, and reuse |
| Interest Calculation | On total borrowed amount from start | Only on the amount used |
| Repayment | Fixed schedule (EMIs) | Flexible/minimum monthly payments |
| Flexibility | Low | High |
| Collateral | May be required (secured/unsecured) | May be required (secured/unsecured) |
What is a Loan?
A loan is a financial product where a lender grants a one-time lump sum to a borrower, who then repays it in fixed installments over a period of time with interest. Loans are used for specific needs such as buying a car, home, or for business expansion. They can be either secured (requiring collateral) or unsecured (based on creditworthiness and often with higher interest rates).
Types of Loans
- Secured Loan: Requires collateral (e.g., car loan, home loan)
- Unsecured Loan: No collateral, relies on credit score (e.g., personal loan, education loan)
- Term Loan: Fixed amount and term, commonly used by businesses
- Business Loan: For business needs, short or long-term
- Personal Loan: For individual's personal expenses
What is a Line of Credit?
A line of credit is a flexible borrowing facility that allows repeated withdrawals up to a fixed limit. Borrowers draw funds as needed, repay partially or fully, and can use the funds again within the approved limit. Interest is charged only on the amount utilized, not on the entire limit. Lines of credit help manage fluctuating expenses or working capital needs.
Types of Lines of Credit
- Personal Line of Credit: For individual use, flexible, unsecured or secured
- Business Line of Credit: For business cash flow management
- Home Equity Line of Credit (HELOC): Secured by home, often used for renovations
- Overdraft Facility: Linked to bank current account (Bank Overdraft)
Difference Between Loan and Line of Credit
The main difference between loan and line of credit lies in their repayment structure, flexibility, and usage. Below is a concise summary to aid exam preparation and concept clarity.
| Point of Distinction | Loan | Line of Credit |
|---|---|---|
| Definition | Fixed one-time lump sum, repaid over time | Flexible, reusable fund limit, draw as needed |
| Purpose | Specific, pre-decided | Multiple or uncertain purposes |
| Interest | On total amount from day one | Only on used amount |
| Repayment | EMIs or fixed schedule | Flexible; pay minimum or full anytime |
| Reusability | No, single use | Yes, withdraw-repay-withdraw |
| Collateral | Secured/Unsecured options | Secured/Unsecured options |
| Examples | Home, Car, Education Loan | Overdraft, Credit Card, Working Capital Limit |
Advantages and Disadvantages
| Product | Advantages | Disadvantages |
|---|---|---|
| Loan |
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| Line of Credit |
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Practical Examples & Use Cases
- Student: Takes an education loan for college fees (single lump sum; repaid in EMIs).
- Entrepreneur: Uses a business line of credit for raw material purchases and pays it back as funds are received from sales.
- Homeowner: Gets a home equity line of credit for interior renovations—withdraws as bills arrive.
For more on finance in business, refer to Functions of Financial Management and explore Working Capital for understanding regular fund needs.
Summary
The difference between loan and line of credit is essential for exams and smart money management. Loans give fixed funds for major needs, with structured repayment. Lines of credit offer ongoing flexibility, perfect for varying requirements. At Vedantu, our Commerce resources help students clearly understand such financial concepts—strengthening both exam performance and daily decision making.
FAQs on Difference Between Loan and Line of Credit
1. What is the main difference between a loan and a line of credit?
The core difference lies in their usage: a loan provides a one-time lump sum for a specific purpose, repaid according to a fixed schedule, while a line of credit offers flexible, repeated access to funds up to a pre-approved credit limit. You can borrow, repay, and borrow again within that limit.
2. What's better, a line of credit or a loan?
Whether a line of credit or a loan is better depends on your needs. A loan suits large, one-time expenses with predictable repayment, while a line of credit is ideal for managing fluctuating cash flow or unexpected expenses, offering greater flexibility.
3. What is the disadvantage of a line of credit?
A key disadvantage of a line of credit is the potential for accumulating high interest charges if you don't manage repayments carefully. Interest is usually charged on the outstanding balance, and high credit utilization can negatively impact your credit score.
4. What is the difference between a line of credit and a loan agreement?
A loan agreement is a legally binding contract outlining the terms of a specific loan amount, repayment schedule, and interest rate. A line of credit agreement sets a borrowing limit and details interest, fees, and repayment terms, but doesn't specify the exact amount borrowed each time.
5. What is a line of credit?
A line of credit is a pre-approved borrowing limit offered by a lender (like a bank). It allows you to borrow funds repeatedly up to the limit, repay, and borrow again, offering flexible access to finances. It's different from a single-use loan.
6. How does a loan work?
A loan involves borrowing a fixed amount of money from a lender, typically at a predetermined interest rate. You repay the principal amount plus interest over a set period through scheduled installments. Loans can be secured (backed by collateral) or unsecured (without collateral).
7. What is the difference between a personal loan and a line of credit?
A personal loan provides a fixed amount for a specific purpose (e.g., debt consolidation, home improvement), repaid in installments. A line of credit lets you borrow, repay, and re-borrow up to a set limit, making it flexible for various expenses.
8. Loan versus credit line: What are the key differences?
A loan is a one-time borrowing, repaid in installments; a credit line offers repeated borrowing up to a limit. Loans often have fixed terms, while credit lines provide flexibility. Interest is calculated differently for each.
9. What is the difference between loan and credit card?
A loan is a single, fixed amount borrowed and repaid according to a schedule. A credit card is a revolving line of credit with a spending limit; you pay interest on your outstanding balance. Both affect your credit score.
10. What's easier to get, a personal loan or a line of credit?
The ease of obtaining either depends on your credit score, income, and the lender's policies. Generally, credit cards (a type of line of credit) are easier to obtain initially than larger personal loans, which often require more stringent eligibility criteria.
11. How does a line of credit affect my credit score?
Using a line of credit responsibly can improve your credit score by demonstrating good credit management. However, high credit utilization (using a large portion of your available credit) can negatively impact your score. Consistent, timely repayments are crucial.
12. How is interest calculated on loans vs lines of credit?
For loans, interest is typically calculated on the entire principal amount. For lines of credit, interest is usually calculated on the outstanding balance. This means you only pay interest on the amount you've borrowed, not the entire credit limit.
