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Having access to various lending options is extremely helpful in times of need or preparing for an event. I will discuss two lending options which provides revolving credit and share the differences between a line of credit vs credit card.
What is a line of credit?
A line of credit in simple words is a flexible revolving credit arrangement that is agreed between you and most commonly the bank (also known as the lender).
The agreement details a pre-set limit. A pre-set limit is a fixed amount that the lender has agreed to provide when you require the funds. Only once you access the funds from the line of credit do you get charged interest. Just like a credit card, you will receive a statement from the lender, detailing the amount used and the interest payable.
One of the most valuable aspects of a line of credit is the interest is much lower compared to a credit card. You may decide to repay the lender as you wish and withdraw as little or as much as you require from the pre-set limit.
This type of credit arrangement is not fixed unlike a conventional loan which has a fixed term to be repaid and a fixed amount which may be accessed.
A line of credit is a revolving credit because the payments and outstanding fluctuate every statement and the amounts are not fixed.
How does a line of credit work?
We have discussed what a line of credit is and will now detail how a line of credit works.
A line of credit is a flexible loan, which means you have the ability to decide how much money you want to borrow. You also have the ability to only pay interest if you choose and can pay any amount exceeding the interest payable. This makes it flexible, convenient and accessible.
Credit Limit
The lender will provide you a pre-approved credit limit to use which makes it convenient. You do not need to reapply for subsequent periods when you require funds.
Interest
Just like a loan, a line of credit accrues interest. The difference with a line of credit is you only pay interest if you borrow and use any money from the line of credit account. Interest is charged daily if you borrow any money and if you do not use the line of credit, you will not pay any interest.
Repayment
You have the choice to repay the amount borrowed from the available line of credit in a flexible manner. This means you could repay the entire balance at any time. You may make any smaller amounts, or regular payments to cover the outstanding balance until repaid in full.
You must review the statement of your line of credit if there is any minimum monthly payment to be made. This is normally $10 or maybe higher depending on the interest payable.
Line of Credit funds
You should normally have instant access to your line of credit funds which can also be viewed and accessed via online banking, mobile banking or by visiting your lending branch.
The line of credit funds can also be transferred instantly from the line of credit account to any other account such as chequing, savings through your electronic banking or in-person by visiting your lending branch.
Just as easy as you were to access your line of credit funds you can repay any amount via electronic transfer from your chequing or savings to your line of credit account.
Revolving Credit
A line of credit is a revolving type of credit as you can borrow and pay as you choose. This revolving process provides you access to funds and also enables you to repay any amount over the interest for your convenience.
Variable Interest
A line of credit once utilized accrues interest that is variable. This means the interest payable fluctuates based on the lender’s prime rate.
Line of Credit Options
A line of credit can be secured or unsecured. The security or lack of security on the amount the lender is providing to you is normally backed by collateral. An example of a secured line of credit is a home owner line of credit. As the line of credit is backed by the home as security it may have a lower interest rate.
An unsecured line of credit is provided by the lender without any collateral and may have a higher rate of interest. This could be a few percentage points higher compared to a secured rate.
When should I choose a Line of Credit?
If you require access to funds and you do not know exactly how much money you need, a line of credit maybe considered.
As the line of credit is a revolving loan, you may repeatedly borrow up to the pre-set limit. The interest is charged only on the borrowed amount. If you have an unexpected expense or requirement that is not planned this could be a good option.
You can choose to repay any amount over the interest payable. This will help you maximize your cash flow as you control your payments.
A line of credit is useful if you have control over your expenses. You must have a plan to repay any amount borrowed. A line of credit vs credit card has many benefits and it is in your interest to find the best fit for your needs.
If you require access to a line of credit, the lender has to approve your application and that process takes time. From a few days to a few weeks, this is valuable time you can save. Plan in advance so you can apply for a line of credit and use when needed. The good news is there is no application fee for a line of credit. The only documents would be concerning your financial history such as pay slips or other income.
Credit Cards
We all use credit cards depending on where you live. Some countries love cash and are evolving. During my recent travel to Ho Chi Minh City, Vietnam, cash is still king.
Credit cards have numerous benefits and my preference is I am in love with credit cards. Technology has come a long way permitting payments electronically and even cardless by using tap and pay.
If you have smaller purchases such as day-to-day expenses, groceries, bills, your credit card is an excellent choice.
How does a credit card work?
We have discussed what a credit card is and will now use an an example to detail how a credit card works.
A credit card is a pre-set amount that is provided by the lender as credit. This pre-set amount is revolving and comes in the form of a physical card or accessible electronically for payments. Just like a line of credit you have the ability to decide how much money you want to borrow. You also have the ability to only pay interest if you choose and can pay any amount exceeding the interest payable. This makes it flexible, convenient and accessible but carries a higher rate of interest.
Credit Limit
The lender will provide you a pre-approved credit limit to use based on your application. As you use your credit card and pay it on time your creditworthiness is determined. This means you show the lender your commitment to borrow and pay amounts. By continuing this cycle, you are demonstrating to the lender your creditworthiness.
This pattern can benefit you as you may receive promotional offers such as TD credit card balance transfer. Consider this a reward for your good usage.
Interest
Just as a line of credit, your credit card accrues interest. Interest accrues daily if you do not pay in full any amounts used as per your statement. Interest on a credit card is much higher and may range from 19.99% to 23.99% per year.
Repayment
You must repay the minimum amount shown on your credit card statement. This could range from $10 to $50 or any amount higher depending on your lender. The minimum amount paid gets allocated to any fees and interest first. If there is any remaining amount is will be applied to transactions. You do not have the choice to repay the amount borrowed in a flexible manner. This is because your statement will decide what you must pay as a minimum.
You may make any smaller amount over the interest due, or make regular payments to cover the outstanding balance.
You must review the statement for your credit card to ensure minimum payment has been applied. If no payment has been received by the lender, your card maybe deactivated. You may also loose access to any available credit limit and may have to pay the entire balance in full if demanded by the lender.
It is very important to have a plan on repayment as credit card interest is much higher compared to line of credit.
To avoid interest on a credit card you must pay in full the entire amount due as per your statement. Any amount short even by a cent will cause interest to accumulate.
Credit Credit Balance
You should normally have instant access to your credit card balance which can also be viewed and accessed via online banking, mobile banking or by visiting your lending branch.
If you have good standing with your credit card issuer you may receive promotions and rewards. An example is the MBNA balance transfer for 0% to 2% over a period.
Credit cards provide numerous benefits in addition to the access of usage. An example is insurance, points, offers, depending on the credit card you choose.
Revolving Credit
A credit card is a revolving type of credit as you can borrow and pay within the limit and date due. This revolving process provides you access to credit for your convenience.
Interest
Credit cards provide access to credit and charge interest depending on the type of credit available. There are two types of interest: Regular purchases and Cash interest. Regular purchases are those for everyday transactions like shopping, dining, gas etc. Cash interest is usually higher and applied for any cash advances or balance transfers.
The lender may choose to provide promotional offers such as 0% promotional annual interest rate. Some lenders may also offer lower interest rates for availing a promotional balance transfer.
Credit Card Options
Credit cards are normally either secured or unsecured. The security or lack of security on the amount the lender is providing to you is normally backed by collateral. An example of a secured credit card would require a cash deposit as collateral. Unsecured credit cards would be provided based on your creditworthiness.
In Canada, if you are a new immigrant and or have no credit history you may be required to deposit some money as collateral. This would benefit you by obtaining a secured credit card and help you build your credit score.
When should I choose a credit card?
If you have everyday purchases and require to pay fixed amounts like subscriptions etc., credit cards are recommended compared to line of credit.
As the amounts you require are planned and most likely monthly or have a fixed frequency, this could be a good option.
A credit card is useful if you have control over your expenses. It will also help you to build or rebuild your credit score. You must have a plan to repay any amount borrowed.
If you love rewards, then credit cards are a must. From cash back, travel, points, insurance, benefits and other promotional activities, credit cards offer a lot.
I hope you are able to the see the value of the line of credit vs credit card. Both lending options are beneficial and have a place for our needs at different times. Review what works for you and plan in advance to reap the benefits.
Summary
We discussed the benefits of line of credit vs credit card. The option of deciding what works for you will be based on your needs, financial commitments and urgency. They both have excellent options and value.
It would be beneficial to obtain and apply for a line of credit and a credit card over a period of time. This will create efficiency and provide you with opportunities when needed.
It is also recommended to have several credit cards with different limits to ensure usability. This provides continuous access to credit with multiple lenders. In terms of lending, a line of credit vs credit card, both are winners and beneficial.
Equifax Canada provides credit scores via a credit report. This helps to understand your payment history, the types of credit accounts you had and have at present along with other details. It is this credit score that helps lenders to assess your creditworthiness.
Author
Adrian Menezes is the Founder, President & CEO of IT’S ONLY HONEY INC. He want’s everyone to be able to increase their financial knowledge and skills. Adrian writes about financial education on Dollar Entry and discusses Canadian things on AJM Canadian.