Both a line of credit and a credit card can mend funding gaps, but major differences give each a competitive edge over the other. Depending on your financial goals, a line of credit or credit card may cost you more than the other: There is no one-size-fits-all best choice. You’ll want to consider the interest rates, fees and limitations before choosing which application to fill out.
What is a line of credit?
A line of credit is a flexible loan that can be used when, if and how you wish. This differs from a fixed loan, where you borrow a set amount and must pay it back with interest over time. Like many types of loans, a line of credit can be unsecured — dependent mostly upon your creditworthiness — or secured, like in the case of a HELOC — a line of credit opened up against your home equity. You can apply for a line of credit through many banks and financial institutions.
The “draw period” on a line of credit determines the amount of time you have to borrow. For instance, you may have a five-year draw period, meaning you can borrow anytime for five years. After five years is up, you’ll have to open a new line of credit. But that’s not without its costs.
You’ll be subject to a handful of fees with a line of credit, including an application fee, annual fee and closing costs. Some lenders may waive closing costs, but there are usually conditions to meet, such as maintaining the account for a certain period of time. Any money you use from the line of credit will accrue interest until it is paid off.
What is a credit card?
Credit cards allow you to make everyday purchases, big and small. You can use a credit card when you’re on vacation, out to dinner or when you’re shopping online. A credit card is useful when you want to have a means of payment on hand without carrying cash, and it’ll also provide more significant protections against fraud than some other payment methods.
When you use your credit card, you’re able to charge payments to the card which add to the account balance and reduce the available credit by the amount of the purchase. You may be charged interest if you don’t pay the entire balance by the due date. Some credit cards offer rewards that you earn by charging purchases to the card.
What are the differences between a line of credit and a credit card?
- With a line of credit you borrow cash, while credit cards are meant to fund your purchases without the cash middleman. While you can generally take out a cash advance on a credit card, they come with hefty fees and interest rates that make them much more expensive than lines of credit.
- Lines of credit typically have lower interest rates, though your mileage may vary.
- Credit card accounts are only closed under certain circumstances, like inactivity or cardholder intervention. Lines of credit have predetermined lifetimes.
- Lines of credit are generally reserved for large purchases, while credit cards can be used for both everyday expenses and large purchases.
- Credit cards often come with rewards and other perks, while lines of credit are relatively frill-free.
What are the similarities between a line of credit and a credit card?
- You have a predetermined credit limit — the maximum amount you can borrow.
- Your financial habits with both a line of credit and credit card affect your credit score. Make sure to make your payments on time and in full, and not to overspend.
- You can access funding for large or unexpected purchases.
- Both lines of credit and credit cards are generally issued by a bank.
- Credit cards or lines of credit can both be secured or unsecured.
When should you choose a line of credit?
A line of credit is often best to finance larger expenses because it typically offers a lower interest rate than credit cards. It’s also handy if you think you might need cash in a pinch. With a line of credit, you can repeatedly tap into and pay off your credit line, giving you flexibility when you need it. An open line of credit may offer a hedge against life’s uncertainties, even if you never end up using it.
When should you choose a credit card?
A credit card may be used for other financial goals, like profiting from rewards or fraud protection. Especially since many credit cards offer no annual fees, it’s also often a cheaper route than a line of credit, given that you can avoid interest by paying your bill in full and on time each month.
The bottom line
A line of credit grants you access to cash at your discretion, making it more flexible than a fixed loan. A credit card is ideal for making daily purchases but can also be used for larger expenses. Credit cards also allow you to earn rewards, travel perks and other benefits, and are often less expensive to open than a line of credit. However, the interest rates on lines of credit are generally lower than those of credit cards.
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