Many people do not have a good understanding of what a line of credit is, but it is a very important thing to understand. When you are doing any type of financial planning, contemplating a loan or have any major financial decision to make, an understanding of a line of credit is very helpful.
This article explains when you will use a loan and when you will use a line of credit.
A loan is when you receive a lump sum of money under set terms and conditions for repayment, with a set interest rate and monthly payment. For example, your mortgage is a loan. The terms of the loan are fully disclosed to you when you receive the money so you know exactly when you are expected to have the loan paid in full.
When purchasing a car you obtain a loan. You can discuss with the car dealer or your banker the terms that best fit you and what you want the life of the loan to be. Of course the shorter the life of the loan is the less you will pay back in interest.
Of course, all of your monthly payment is not going toward paying down the principle of the loan. Much of that payment is applied to interest.
At the outset, the majority of the monthly payment you will be applied to interest. As time goes by this changes and you begin to pay more towards the principle each month.
A line of credit works differently in that it is an amount of money available to you to use when and as you see fit. You may set up a line of credit without having a specific purpose for the money at the time. Interest rates for lines of credit are figured based on prime, which is established by the Federal Reserve.
Hopefully this article can help you understand the difference between a loan and a line of credit. It is important to understand the difference between these because each of these financial products has its uses and its place within your financial life.
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