Everyone has a time in their life when they need access to more cash than they have available - whether you need a new car, want to renovate your kitchen, or simply want to create an emergency fund. To help create that financial flexibility, both loans and lines of credit give you a sum of money you will be expected to pay back. We're here to help you understand the difference between the loans and lines of credit.
Types of loans
There are two types of loans that may be extended to you - a secured loan, or an unsecured loan. All loans are usually created for a specific purpose (like buying a car), are structured and have an assigned payment date and schedule.
A secured loan requires some form of collateral to prove your ability to pay the loan back. Collateral can refer to your car, your house, or some other significant asset that will act as a promissory note to the bank that, should you default on your payments.
An unsecured loan, on the other hand, does not have the same collateral requirements. That might sound like a bonus, and it is, but it comes with a cost. The interest rates on unsecured loans tend to be higher and you will need a higher credit score to qualify.
What is a line of credit?
A line of credit is an allowance of sorts, given to you to draw from as needed and can be used for any purpose. It is a great borrowing tool for large renovations or other big purchases. It is different than a loan because the funds aren’t forwarded to you in a lump sum that needs to be paid back in a specific time frame.
Pros of line of credit
A line of credit is a handy tool to have as a float for unexpected expenses. Unlike other forms of credit, LOCs often have lower interest rates – typically the Bank of Canada rate plus a half a percent or so. They also have the added benefit of a more liberal payback requirement than a loan, with no set date that the funds need to be returned in full. Instead, you are only required to pay the interest accrued on the amount you have withdrawn.
Cons of a line of credit
The only true downside of a line of credit is the borrower's financial discipline. Someone who is less disciplined with their spending and repayment efforts can find themselves with a significant amount of debt in a very short amount of time.
Different types of LOCs
There are four types of lines of credit available in Canada:
- Secured line of credit – this type of credit requires collateral to back your loan. This is often required in situations where the borrower has many assets but little cash flow or proof of income. This can also be a tool to help re-build bad credit score.
- Home equity line of credit (HELOC) – this line of credit is secured against your house. Many mortgages come with an option to activate this type of account. As the account is connected with your mortgage, you'll often get extremely low interest rates.
- Unsecured line of credit – this type of credit is often provided with no collateral required:
- Personal line of credit – commonly used to cover unexpected expenses or to bundle loans with higher interest rates to pay them down quicker
- Student line of credit – for post-secondary students who need a low interest loan to cover basic expenses related to schooling (tuition, books, rent, etc).
If you need to borrow some money but still aren't sure which option is best for you, give us a call and we’ll help you walk through the borrowing options that best fit your needs and financial goals.