Loans and revolving lines of credit are two different ways that individuals and businesses borrow money from lenders. Understanding the difference between the two is critical in being able to decide which the right one is for your situation and how it will affect your credit in the long- term.
A revolving line of credit is a type of credit that can be used repeatedly up to the approved limit until the account is open and the payments are regular and on time. Unlike a loan, the borrower has continuous and repeated access to the line of credit while it is active.
A term loan on the other hand is a non-revolving line of credit, which means the borrower has access to the entire funds only at one time and subsequently pays the principal and interest as per the monthly payment schedule.
Revolving line of credit
A Revolving Line of Credit (RLOC) offers a predetermined borrowing limit that the borrower can tap into at their convenience, repay, and then access again as needed. This flexible credit arrangement can be employed for various purposes, providing adaptability to financial demands. Despite its convenience, RLOCs generally carry higher interest rates compared to traditional loans.
However, interest is only applied to the utilised portion of the credit. Typically utilised for managing smaller expenses during periods of constrained cash flow, RLOCs prove useful in maintaining operational fluidity. Notably, collateral requirements are often minimal or even waived if the account holder boasts a strong history of business transactions and creditworthiness.
A traditional loan provides the borrower with the entire approved amount in one lump sum, typically used for specific purposes such as buying a car, home, or funding education. These loans generally come with lower interest rates and can be either secured or unsecured. The interest is charged on the entire lump sum amount, whether it is used or not, right from the start of the loan. This type of loan is often utilised for larger purchases like homes or cars and may require collateral for secured loans, offering lower interest rates in return.
How do I know which product is better for me?
When shopping for credit, it is important to consider your unique situation- your needs, financial goals, ability to pay back etc. You will also want to compare interest rates, additional fee and repayment terms. If you need money for a large purchase such as equipment or real estate, a term loan may be the best option for you. On the other hand, if you need access to funds for working capital or to pay salaries, for example, a revolving line of credit would be a better option.
An RLOC (overdraft) facility is a flexible credit line linked to a business month on month, allowing for short-term borrowing and repayments, while a loan provides a lump-sum amount for specific purposes, repaid in fixed instalments over a defined period. The choice between the two depends on the individual’s financial needs, situation, and preferences.
Both types of credit can be useful depending on the situation. Make sure you choose the option that is best suited for your purpose. Whether you choose revolving or non-revolving credit, carefully consider the terms and borrowing cost and stick to the repayment agreement so you do not hurt your credit score.
Manoj Sharma, Chief Business Officer, MyShubhLife