Did you know there is a big difference between a credit card and a line of credit? Most people don’t, or they only understand the basics. In this blog post, we will explore the differences in more detail. We’ll also talk about when it might make sense to use each type of loan.
Difference between credit card and line of credit
Credit cards and lines of credit are used for different purposes. A credit card is a type of loan, whereas a line of credit is an amount that can be withdrawn at any time. The difference between the two can be summarized as follows:
- Credit cards offer the ability to carry debt over long periods of time with high interest rates, while a line of credit offers quick access to funds with lower interest rates.
- With a line of credit you have unlimited borrowing power up to your limit, but with a typical credit card, you only have about $4,000 in borrowing power before being cut off by your bank or issuer. You should know how much it will cost if you borrow money on either.
Advantages of using a line of credit instead of a credit card
All you need to do is reach an agreement with your lender and you can get as much money as you like. Interest rates on a line of credit are usually cheaper than on a credit card, and you’re not committed to paying off the debt in monthly installments as you would be with a traditional loan. You’re not required to make regular minimum monthly payments on a line of credit. If you don’t pay off your line of credit in full one month, the outstanding balance is added to the next month’s balance and becomes subject to compound interest, unlike a typical loan or mortgage with fixed-term installments over an agreed period and paid in full at the end. Your debt will grow quickly if you don’t pay it off each month, but unlike with a credit card, you’re allowed to miss payments without penalty. And unlike with a credit card, your credit score can improve with consistent on-time payment over time.
Disadvantages of using a line of credit instead of a credit card
There are a few disadvantages to using a line of credit instead of a credit card:
- If you don’t pay off your line of credit in full one month, the outstanding balance is added to the next month’s balance and becomes subject to compound interest, unlike a typical loan or mortgage with fixed-term installments over an agreed period and paid in full at the end. Your debt will grow quickly if you don’t pay it off each month, but unlike with a credit card, you’re allowed to miss payments without penalty.
- Your credit score can be negatively affected if you don’t pay your balance in full each month.
- A line of credit is typically secured with an asset such as a house.
When should you use one over the other
There are times when you should use a line of credit instead of a credit card:
- When you need to borrow more money than a credit card can offer.
- When you want to avoid being committed to monthly installments over an agreed period.
- When you don’t want your credit score to be negatively affected if you can’t make a payment.
- When you want to continue using your line of credit even if you miss a payment.
There are also times when you should use a credit card instead of a line of credit:
- When you don’t need to borrow as much money as a line of credit can offer.
- When you want to benefit from lower interest rates than what’s typically offered on lines of credit.
- When you want to make consistent payments each month like you would with a traditional loan or mortgage.
- When you want to keep your debt low and pay it off in full without penalty if you can’t make a payment.
- When the interest rates on your line of credit are higher than those on your credit card.
- When you want to take advantage of introductory rates or offers that typically come with credit cards.
- When it’s in your best interest to improve your credit score, which can happen when you make consistent on-time payments each month.
When you have a clear understanding of the pros and cons of each, it will be easier to make an informed decision about which is right for your financial goals. Which credit card or line of credit do you think would work best for your situation? Let us know.
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