Key Differences: Line of Credit vs Credit Card
A line of credit and a credit card are both forms of revolving credit that provide borrowers a convenient way to access or buy money. Understanding the difference between line of credit vs credit card can help you better navigate both topics. There are a number of notable differences between the two. The table below summarizes them.
Key Features |
Line of Credit |
Credit Card |
Average APR |
Typically, lower than a credit card, especially when secured with collateral |
Typically, higher than a line of credit |
Credit Limit |
Typically, much higher than a credit card, especially when secured with collateral |
Typically, much lower than a line of credit |
Grace Period |
No grace period |
Typically, 21 days |
Draw Period |
Typically, a few years; longer periods exist, with some rare arrangements offering an infinite draw |
Infinite draw period, assuming you make the required minimum payments |
Fees |
Potentially, activation fees, annual maintenance fees, draw fees, late payment fees, and returned payment fees |
Potentially, annual maintenance fees, balance transfer fees, cash advance fees, late payment, and returned fees |
Credit Score Requirements |
Typically calls for good to exceptional credit |
Wide availability for high to low credit scores, with increasingly high APRs |
Rewards/Perks |
No rewards/perks |
Diverse rewards, including cash back statement credits |
Common Uses |
Significant outlays, such as capital expenditures, operating expenses associated with seasonal cyclicality, and emergency repairs |
Recurring expenses, such as inventory purchases, rent, utility bills, and travel expenses. |
When To Use a Credit Card or Line of Credit
In light of their differences, there are certain situations when using a line of credit is optimal and other situations where credit card utilization is more sensible.
A Line Of Credit is most useful when you have the potential for unexpected, large outlays. Especially if it is a revolving line of credit. It gives you the flexibility to address these issues without the need to precisely time and fund them via a cash reserve or a well-defined installment loan.
A Credit Card is most useful when your potential spend is low to moderate. It’s a highly convenient way to facilitate purchases without drawing down on your cash reserve.
You should only use a credit card for everyday spending if you intend to pay your bill off each month by the due date. Doing so you’ll avoid accumulating problematic debt, needing a debt consolidation loan and paying interest of 15-30 percent.
What is a Line of Credit ?
A line of credit is an automatic recurring loan up to a specified limit which you will pay for at an agreed point in time in the future.
Some
lenders will use your current existing banking relationship to establish trust
and once established, you can buy money as frequently as you like.
You only
pay interest on the money you borrow. However you may be charged a
fee each time you borrow from the business line of credit. The outstanding loan balance and interest simply revolve into the next billing period.
There are
two types of lines of credit:
Secured
A secured
line of credit is when you pledge objects of value such as business equipment
or personal assets, like an automobile or home to lower the risk for the
institution lending you money.
Secured
lines of credit loans are less risky for lenders. They have better terms: lower
interest rates, fixed-rate and variable-rate and longer terms of availability.
Secured lines are much riskier for borrowers or buyers of money, because they
put your assets at risk.
Unsecured
An
unsecured business line of credit does not require a security pledge. This means there
is a higher risk for the lender. As a result, to mitigate their risk, the
interest rates or the price of the money you buy is often higher.
In addition
their policy requirements are often more complex. They may require a cosigner
which puts whomever that is at risk if you default.
How Does a Line of Credit Work?
Most lending institutions offer a combination of physical and electronic draw options:
Physical
Transactions:
Your loan
issuer or sales can give you checks to write. You may also be able to draw
funds via in-person or over-the-phone transactions.
Online
Transactions:
You can
arrange to electronically execute draws (Receiving the loan or part of it which
in effect is a purchase of money) via your personal computer, laptop, or
smartphone.
There are
two ways in which vendors offering credit lines determine the cost of the money
you will be buying.
1. Variable
Rate
A variable rate is an interest rate that fluctuates over time. It fluctuates because it is based on the governmental understanding of what the interest rate should be which, in turn, is dependent on many economic market factors that change.
For
example: let's say that you need $1,000 to start a business. Professional Banana Lenders offer you a price of variable interest rate at prime plus 5%. That means that the interest rate or the cost of the money you are buying equals whatever the prime rate is plus 5%. If the prime rate is 4%, then your interest costs will be 9% of the amount you borrowed.
2. Fixed
Rate
With a fixed rate, the interest charged on the amount you borrowed will not fluctuate throughout the life of the loan. It remains the same regardless of what is happening in the financial market economy that would affect the cost of the money or interest rate in the variable interest rate structure.
What is a Credit Card?
A credit
card is a type of line of credit or financial mechanism that lends you money
very easily and instantaneously.
This type of lending happens in real time as you buy something in-person, over-the-phone or online. They are also a form of a personal line of credit.
- Most credit
cards are unsecured and they carry
high interest rates.
- Those with
the lowest interest rates and most flexible payment terms are reserved for
borrowers with the highest credit scores.
- You don't
need an exceptional credit score to get a credit card.
How Does a Credit Card Work?
Making
purchases with a credit card can be done by physically swiping or inserting the
card in a terminal. You can also use it to purchase items by verbally
communicating the card’s number, expiration date, and security code over the
phone. Using a credit card can also be done by entering the card’s number,
expiration date, and security code into an online payment form.
Once a
transaction is processed the purchase amount is added to your account balance.
This reduces your available credit and all purchases are tracked and reported
to you, along with any accrued interest, via periodic billing statements.
Each billing period spans 30 days with payment due no less than 21 days following the issuance of the billing statement.
- Most credit
cards offer a grace period on each bill. Essentially, this allows you to avoid
any interest charges by paying the entire balance by the due date.
- If you pay
less than the full balance, you lose the grace period privileges. This means
you will be charged interest on the unpaid portion of the balance, and you will
be charged interest right away on any new purchases.
- You must
pay at least the stipulated minimum amount by the due date. Failure to do so is
likely to result in late fees, a higher APR, and a delinquency notice on your
credit report.
Alternatives to a Line of Credit
An even
better idea than using these types of money purchasing systems is to provide
the money yourself:
Focus on saving. Establish a rigorous, but realistic budgetary framework – with a focus on generating savings each month. Gradually build up a money reserve you can tap for unexpected operational needs and capital expenditures.
Establish more lenient payment plans. Work with your key vendors to extend your payment terms. This can improve your near-term cash flows and give your more day-to-day flexibility.
Sell
unnecessary fixed assets. Oftentimes, businesses acquire assets that become
obsolete over time. Assess your stock of fixed assets to determine if you are
holding onto any unnecessary equipment, furniture, or automobiles. Selling
these assets could be an easy way to raise cash.
Leverage
local support. Explore your community to find business associations, mutual
assistance groups, and stimulus-oriented non profit organizations that can
provide free consulting services, monetary grants, and donations of real assets
to facilitate your business endeavors.
Key Points :
- A line of
credit provides you access to more cash, but the availability of the line is
limited.
- With a
credit card, your access to funds is lower and costlier, but you have the
ability to utilize the credit indefinitely.
- Both a
credit card and a line of credit loan can be beneficial, which is why many
businesses maintain both.
- Ideally, a
credit card should be used for high volume transactions with relatively
moderate costs, such as service subscriptions, travel expenses, meals, and
supplies.
- Conversely,
a line of credit should be used sparingly, perhaps, for unexpected capital
expenditures or operating expenses associated with seasonal changes.