A line of credit and a loan are two powerful financial tools. Each has traits that make them highly advantageous in certain situations. This post looks at the differences between and the strengths of the two.
Loans come in many varieties, but they all have the same basic structure: The lender extends a lump sum of money, and the borrower agrees to return that money plus interest via regular payments—usually monthly—over a set period of time. Loans may be secured by collateral or unsecured, and they may involve additional fees.
In many cases, borrowers need to have a specific purpose in mind to obtain a loan, with examples including loans for equipment and real estate. Because they offer large chunks of money, loans are attractive for making major purchases that would otherwise be unaffordable. Their set payment structures also assist when budgeting.
Lines of Credit
Lines of credit do not provide all of their funds in one lump. You can take out money until you hit the line’s credit limit, at which point you will need to pay down your outstanding balance. But if you take out less than that amount, you are only responsible for paying back what you withdrew.
If a loan provides a flood of money, then a line of credit provides a well from which your business can draw. As you make monthly payments, the well replenishes itself, meaning you can withdraw funds again in the future. Investopedia’s Adam Hayes writes that this type of financing is especially attractive for its flexibility. For instance, a single line of credit can act as both an emergency source of funding and a way to jump on opportunities as they come up.
The funds from a line of credit typically aren’t limited by considerations of timing or use. Interest rates may be variable and differ greatly between lenders. Like a loan, a line of credit can be secured or unsecured, with the latter typically having steeper interest rates.
Interested in the types of financing you may be able to access? Contact Magis Funding to learn more.