Startups usually need a lot of capital to meet the financial obligations that come with opening a new business. Surprisingly, many people don’t know the difference between a loan and a line of credit.
Having the knowledge to differentiate the two is crucial when making big decisions like these. With the different options in today’s financing world, it can get really confusing when choosing between these two basic borrowing choices. Each has its own benefits and drawbacks so making the wrong choice could be costly to your company.
This guide is made to talk about the two most basic borrowing choices so you don’t have to make a wrong decision about the future of your business.
What is an Unsecured Loan?
Unsecured personal loans are a quick and simple way to get money for a variety of planned or unplanned expenses. The amount of money you are required to pay back is already known from the time you started to borrow.
The amount to be paid is kept similar so you can pay it back in fixed monthly payments. Rates are usually fixed and there is no need to deposit for prepayment fees. Loans are what most businesses usually resort to if they need funds.
Benefits of a Loan
Loans give you your requested money upfront and usually a specified time is agreed upon on when you have to pay the loan. Interest rates are charged on the entire duration of your proposed loan. Here are some good reasons to avail a personal loan:
- Interest Rate – The lender will ask usually ask for a fixed interest rate that will not change over the period of your loan or they will ask you to pay a variable interest rate which falls or rises depending on the current market rates.
- Discount – The lender of your loan may provide a limited time discount if you are going to avail a big loan amount.
- Lump-sum – If the lender approves your loan and both agrees with the contract of the loan, you will receive all your money upfront.
- Term – The loan term is the time on which you will be making the payments until everything is full paid back. It usually ranges between a year to seven years.
- Flexible payments – You can choose how and when you will be paying your monthly debts but this depends on your lender
What is a Line of Credit?
A line of credit is also a financial resource but it is less used compared to loans. Lines of credit are commonly used by businesses and people who avail home equity because it is more flexible. Lenders usually have a borrowing limit depending on the status of the person asking for the money.
More funds are allowed to be borrowed only after the initial amount has been paid. Most lines of credit have no end date. Your monthly dues will also depend on how much credit you have at that time. The only important factor when using lines of credit is that one must pay back one line of credit before you can avail another line of credit. Private lines of credit usually come with low annual fees.
Benefits of Line of Credit
Lines of credit have a max credit limit. The good thing about it is you will only be charged with interest on the funds you use. Payments are made every month but there are no fixed terms. Lines of credit are always available to the user as long as the minimum required payments are met.
- No fixed repayments – If the minimum required monthly payment is met, there are no fixed repayment amount
- Choice to improve max credit limit – The bank or lender can give you a choice to increase your credit’s max limit that will satisfy your needs.
- Interest rate – Interest is paid monthly and will only be charged on the user’s borrowed amount
- Withdrawals are flexible – Users can withdraw money from their line of credit whenever they like as long as the user does not exceed their daily limit.
Which Suits You Best?
In a loan, you will begin accumulating interest right away. This leads to a more responsible way to pay fixed payments over a period of time. With a line of credit, you will not pay any interests until you use it. You will only be charged on the outstanding balance you have used.
Having a line of credit means you can access funds anytime and repay it within a certain time period. This is useful when the user has big projects like remodeling a house where the expenses can change constantly. Lines of credit are largely beneficial to companies and organizations. You may have to face higher interest rates but this is not a problem if you are only paying back what you actually spend. Lines of credit could take away the hassle of finding an extra source of money when the expenses are way higher that what is expected.
However, it may be hard to qualify for a line of credit. To be able to be given a line of credit, you will be required to have a good credit score. If you have a poor credit score, you can always find a good loan you are qualified for. But you must always take note that lower credit scores means higher interest rates.
Loans can be a better option for various reasons too. Loans allow users to limit what they can borrow rather than having an open balance. Loans also give users to predict the needed monthly payments so they can budget for. There is always a chance to accumulate debt when using either loans or lines of credit. So before availing them, make sure that you can repay them. It is crucial to consider how much funds you will need in the short or long term to help you choose which is best suited for you.