The Difference Between Loans, Lines of Credit, and a Credit Card

While debt may have a generally negative reputation for many consumers, the reality is that there are different types of debt that can be used strategically at various times throughout your life. Debt balances can become high and unmanageable when these accounts are not used responsibly or when individuals do not understand how the different types of debt can be used effectively. The primary types of debts are personal loans, lines of credit and credit cards. When you learn more about the features of these various options as well as their important differences, you may be able to manage your debts more strategically.

A Closer Look at Personal Loans

Personal loans can be secured or unsecured. A secured personal loan is a loan that has collateral linked to it. A good example is a car loan. Many secured loans are used to purchase the collateral linked to the debt, such as is the case with a typical car loan. An auto title loan is a variation of a traditional car loan, and it has a much shorter term length. A title loan actually is a special type of loan that takes equity out of a vehicle that is already owned.

An unsecured personal loan does not have collateral. A common type of unsecured loan is a signature loan, which is essentially based on your good word that you will repay the loan funds as agreed. Collateral may be repossessed or seized if you default on a secured loan. Because there is no collateral associated with a personal loan, defaulting may result in the loan going to collections or the lender taking other efforts to recoup the money owed.

With any type of personal loan, you will receive the financial benefit of the loan amount in full up-front. For example, when you take out an unsecured personal loan, the bank will provide you with cash or a bank deposit for the full loan amount. Some loans restrict your use of these funds, but other loans give you considerable freedom to use the money as desired. A personal loan has a fixed term, and it usually requires repayment of the loan in equal monthly installments throughout the term period. The term length can vary dramatically.

How Lines of Credit Are Different

A line of credit may be secured or unsecured. A common type of secured line of credit is a home equity line of credit. This type of financing uses the equity in your home as collateral. An unsecured line of credit does not have collateral. With a line of credit, you are typically permitted to take draws against the credit line for a period of time. At the end of the initial period, no additional draws against the credit line are permitted. Throughout the entire loan period, you may be required to make payments based on the amount of money that you have borrowed. Like a personal loan, a line of credit usually has a fixed term. This means that the entire amount of money that you have borrowed must be repaid through regular payments by the end of the loan term.

Understanding Credit Cards

A credit card is typically an unsecured type of debt, but there are some secured options. Secured credit cards require you to make a cash deposit upfront, and this deposit establishes your credit limit. Secured credit cards are usually offered to individuals who do not have a credit history or who need to improve their credit rating.

Unlike lines of credit and personal loans, credit cards have a revolving term. They also usually have a much higher interest rate than the other options. These two factors generally make a credit card more difficult to pay off than a line of credit or a loan. In addition, a credit card payment amount fluctuates based on the amount of the current outstanding balance. It is common for individuals to use a fixed term personal loan to consolidate and pay off credit card balances.

Personal loans, lines of credit and credit cards are often viewed as being fairly similar because they are all forms of personal debt. However, now that you know more about what they are and how they are different, you can see that some types of debt may be more strategic and beneficial for you to use than others. Before you take out a loan or open a new debt account, carefully review all of the options available so that you can make a smart decision about how to manage your finances.