Do you know what the main differences between loans and credit are? The loan and credit (or line of credit) are the two most widespread and used forms of financing. Although most people confuse them and think that they are the same, they are different financial products with different characteristics. This article will explain what each consists of and how they differ.
What Is A Loan?
After the checking account, the loan is the most demanded banking product. Everyone, at some point in their life, takes out a loan to finance a consumer good, such as a house or an appliance, pay bills, or, although it is not recommended, take a trip. A loan consists of an entity financial institution (lender) making available to us (borrower) a certain amount of money that we will have to repay in the future with conditions agreed in advance, in specific terms, and according to the agreed interest rate. Once the loan has been granted, the entity fully transfers it to our checking account. From that moment on, we can make use of it. In return, we will have to gradually return the money received in regular instalments (monthly, quarterly, semi-annual…) over the agreed period. Therefore, the operation has a specific duration previously agreed upon (in the case of personal loans is usually a maximum of 8 years, and mortgage loans can be up to 40). Interest is charged on the entire capital borrowed. In summary, a loan meets the following characteristics :
- All money is delivered at one time. If we request a loan of 20,000 euros to buy a car, the bank will transfer that amount to our checking account.
- The amount borrowed (capital) and the interest generated by the debt must be repaid within a term agreed in advance. For example, six years.
- The return of the money is made in regular instalments. For example, monthly instalments.
- Interest is calculated on the totality of the money you have lent us (usually using the French amortization system).
What Is A Credit (Or Line Of Credit)?
Credit is a financial product very similar to a loan and widespread as a financing alternative, although perhaps more in professional environments ( self-employed and SMEs) than among households and families. It can also be used to finance purchases and, above all, to achieve liquidity. Unlike the loan, it is much more flexible. In practice, the operation of credit lines could be similar to that of credit cards: the financial institution makes a specific amount of money available to the borrower for a certain period. , and this can make use of it as needed. Therefore, there is no need to use all the money at once, but it can be done little by little, and you only have to pay interest for the amount used. A smaller interest or a commission is usually paid for the amount of money that is not used. For example, a self-employed person with liquidity problems to pay bills can request a credit line of 3,000 euros from the bank for 12 months. During that time, you can use that balance according to your needs: 1,500 euros the first month, 200 euros the second month, 700 euros the third… and you will only pay interest for the money you use. In summary, a line of credit has these characteristics :
- The money is not delivered all at once but little by little (according to the borrower’s needs). As this money is returned, it can be used again.
- The line of credit is available for a certain time (12 months in our example).
- Interest is calculated on the amount the debtor uses and not on the total amount of the credit.
Differences Between A Loan And A Line Of Credit
As you have just verified, a loan and a credit are two financing alternatives with many differences. Let’s review the main ones:
- The purpose of both products is different. While the loan is usually used to finance the purchase of goods, the line of credit is mainly used by self-employed workers and SMEs to solve specific liquidity problems.
- In the loan, the total amount is delivered at one time at the initial moment, while with the line of credit, the borrower can use the money little by little, as needed.
- The amount of money requested from the bank is fixed in the case of loans. On the contrary, this amount can be increased with the credits if the client needs it.
- In loans, you have to pay interest for one hundred percent of the capital, while in credits, interest is only paid for the capital that has been used.
- Loan interest rates are often lower than lines of credit.
- The repayment terms of the lines of credit are shorter than those of the loans. However, lines of credit can be renewed multiple times at maturity.
Which One Interests Me More?
In short, we are dealing with products that, although they seem to be the same at first, actually have quite different characteristics. The choice between them will depend on the purpose pursued by the person requesting it. In the case of an individual, the loan is usually a better option than credit since the interest rate is lower and the repayment term is longer. Broad. On the contrary, the credit line may be a better alternative for the self-employed and SMEs, although only in certain cases in which punctual financing is needed. And you, which one convinces you the most?