Credit card vs. line of credit: What's the difference?
While credit cards offer plenty of value-generating benefits and can come with strong earning rates, they generally have higher interest rates than other financial offerings, making them costly if you don't pay off your balance on time.
If you're looking to borrow large sums of money or trying to fund an upcoming purchase, a credit card might not be the smartest choice. If you have a good credit score, a line of credit could be worth considering.
What is a line of credit, and how is it different from a credit card? Keep reading to find out.
What is a line of credit?
A line of credit is a loan that lets you borrow and repay funds multiple times within a specific time frame. The amount and frequency vary depending on the type of loan you obtain, but once the initial draw period ends, you can no longer borrow additional funds. You then enter a repayment phase where you must repay the balance, along with interest, through monthly payments.
Different types of lines of credit include personal lines of credit, business lines of credit and home equity lines of credit, which are loans that use your home as collateral.
A line of credit allows you to access cash whenever needed, allowing for more flexibility in managing your finances. Additionally, interest rates on a line of credit are usually lower than that of credit cards.
It's important to note, though, that qualifying for a line of credit generally requires a strong credit history and even collateral, such as property or assets.
What is a credit card?
A credit card is a card that allows you to make purchases using borrowed funds, as opposed to a debit card, which taps into funds you already have. You can avoid generating interest on your outstanding balance by repaying the borrowed amount in full before the monthly due date.
If you don't pay off the full balance, you must make the minimum monthly payment to avoid late fees. The current average annual percentage rate on credit cards is over 20%, which can be very costly if you carry a balance and allow your debt to snowball.
Related: 7 things to understand about credit before applying for a new card
Line of credit vs. credit card: Differences
Lines of credit and credit cards share a handful of similarities but have separate, distinct rules regarding borrowing and repayment.
With a line of credit, there are specific time limitations on borrowing. During the initial draw period, you can borrow funds that must be repaid within the designated repayment period. Eventually, the account will close on a predetermined date.
On the other hand, credit cards allow you to borrow up to the credit limit repeatedly over an indefinite period. As long as the account remains in good standing, it will stay open.
Another notable difference is that lines of credit provide easy access to cash, while credit cards don't. To obtain cash from a credit card, you need to use a cash advance feature, which typically comes with higher APRs reaching nearly 30% and interest charges that start accruing immediately.
Line of credit vs. credit card: Which is the better option?
If you have a good credit score and need cash fast, a line of credit can be a serviceable alternative to a credit card. That's especially true for something like a home renovation, where the total cost and payment schedules may be unpredictable.
A credit card is the most suitable option for those looking to establish a long-term credit history and make everyday purchases. That's because credit cards are more accessible for individuals with a less-than-perfect credit score, and as long as the account remains in good standing, it can remain open.
Bottom line
A line of credit can provide lower interest rates than a credit card, flexible borrowing and repayment terms, and the potential to improve your credit scores. However, in some cases, qualifying for a line of credit requires a strong credit history and even collateral (such as property).
Conversely, credit cards offer convenience and ongoing access to funds, and they are much easier to obtain and maintain. While a line of credit could make sense for trustworthy borrowers looking to fund a one-time purchase, for most individuals, a standard rewards credit card will probably be the best way to go.
Read more about the best credit cards on the market right now.