Loans and lines of credit
You have decided to buy a product you really need (or want). But you’re short on money to pay it outright and need to finance it. So, you consider asking for a loan or a line of credit. Do you actually know the difference between the two?
While everyone thinks they are the same, they are not. The main differences between loans and lines of credit are:
- How you access the money: in the case of a loan, you receive a lump sum, usually by means of a deposit into your account.In the case of a credit line, the bank allows you to draw an amount of money up to a certain limit that you can spend as the need arises. You can make use of the credit line not only by means of a deposit into your account, but also by other means, such as a credit card.
- How interest is calculated: in both cases interest is paid based on the amount of money drawn. In the case of a loan, for the full amount. And in that of the credit line, as you use the money. However, for a line of credit, the bank might charge you a fee for the amount not drawn.
- How the money is repaid: in a loan, the amount drawn is fixed. Therefore, it is usually agreed to repay that amount in regular instalments over a fixed term. When you arrange a loan, the bank usually provides you with a repayment schedule detailing each and every payment you will have to make. This does not happen with a line of credit, as the amount to be repaid is variable. However, the credit agreement should clearly indicate the conditions set to repay the capital. You are also entitled to receive a statement explaining the calculations made for each settlement of interest or fees.
- Term: Loans have fixed terms. Lines of credit should also have an initial term, but it is common to provide for renewals or extensions based on the arrangements you make.
Now you have seen the differences, you can decide which product suits you best.
In any event, be aware that your bank is required to explain the products and services it offers adequately. You should not hesitate to ask for explanations before making a decision. Before you choose one or the other option it is particularly important you are clearly aware of how instalments are calculated, of the existence of other possible costs or penalties and of any consequences in the event of default by you.