Introduction

When you need to borrow money, two common options are a loan and a line of credit. Both provide access to funds, but they work differently.

The core difference: a loan provides a lump sum that you repay in fixed installments over a set period. A line of credit offers ongoing access to funds up to a limit, allowing you to borrow, repay, and borrow again as needed.

The right choice depends on your needs. For a one time expense with a clear cost, like buying a car or consolidating debt, a loan’s predictable structure is often better. For ongoing or uncertain expenses, a line of credit’s flexibility could be a better fit.

This article explains how each option works, what they cost, and when each makes the most sense.

What Is a Loan?

A loan is a borrowing arrangement where a lender provides a fixed amount upfront, which the borrower repays over time with interest. Repayment begins shortly after disbursement, usually through monthly installments, and continues until the balance is paid in full.

How Loans Work

With a loan, you borrow a specific amount at a stated interest rate for a defined term. The lender disburses the full amount (minus any fees), and you repay it on a fixed schedule.

Most personal loans have fixed interest rates, so monthly payments stay the same for the life of the loan. This predictability makes budgeting easier and provides a clear payoff date.

Once the loan is repaid, the account closes. Any additional borrowing requires a new application.

Common Types of Loans

Different loans serve different purposes:

Personal loans are usually unsecured and can be used for many needs, including debt consolidation, medical expenses, or home improvements. Amounts often range from $1,000 to $50,000, with terms of one to seven years.

Auto loans are secured by the vehicle and typically offer lower rates than unsecured loans.

Mortgage loans are secured by real estate and have long terms, usually 15 to 30 years, for purchasing or refinancing property.

Student loans cover education costs and include federal and private options with varying terms.

Asset-backed loans use non-traditional collateral such as investments, savings, or crypto to provide liquidity without selling the underlying assets.

Key Characteristics of Loans

Loans share several defining traits:

• The borrowed amount is fixed at origination.

• Interest accrues on the full balance immediately.

• Repayment follows a set schedule with consistent payments.

• Terms vary, but personal loans often run one to seven years.

• Once repaid, the account closes.

What Is a Line of Credit?

A line of credit is a flexible borrowing arrangement similar to a credit card. Instead of a lump sum, you’re approved for a maximum limit and draw funds as needed.

How Lines of Credit Work

After approval, the lender sets a credit limit based on factors such as credit history, income, and collateral (if applicable). You can borrow any amount up to that limit.

You pay interest only on what you borrow. For example, with a $25,000 limit, drawing $5,000 means you pay interest only on $5,000. As you repay, your available credit replenishes. This revolving structure allows repeated borrowing without reapplying, as long as the account remains in good standing.

Most lines of credit have a draw period, often two to five years, followed by a repayment period when no new draws are allowed and the balance must be paid down.

Common Types of Lines of Credit

Personal lines of credit (PLOCs) are often unsecured and offer lower rates and higher limits than credit cards.

Home equity lines of credit (HELOCs) are secured by home equity and usually carry lower rates, but your home is at risk if you default.

Business lines of credit help manage cash flow and short-term expenses.

Securities-backed lines of credit use investment portfolios as collateral.

Key Characteristics of Lines of Credit

Lines of credit typically feature:

• Variable interest rates, though some lenders offer fixed-rate options on portions of the balance.

• Interest charged only on outstanding balances.

• Payments that vary with usage and rates.

• Revolving access without repeated applications.

• Possible fees, such as annual, draw, or inactivity fees.

• Stricter qualification standards than many loans.

Differences Between Line of Credits and Loans

How You Receive Funds

Loans provide the full amount upfront in a single disbursement. Lines of credit provide access to funds only when you draw from the account, giving you control over timing and amounts.

Interest Structure

Loans accrue interest on the full principal from disbursement. Lines of credit accrue interest only on the amount used. Loans usually have fixed rates. Lines of credit typically have variable rates tied to benchmarks like the prime rate.

Repayment Terms

Loans have fixed monthly payments over a set term. Lines of credit require variable payments based on balance and rate, with different rules during draw and repayment periods.

Reusability

Loans are one-time transactions. Once repaid, they close. Lines of credit are revolving, allowing repeated borrowing as you repay.

Predictability

Loans offer predictable payments and total cost. Lines of credit are less predictable due to variable rates and flexible borrowing.

Secured vs Unsecured

Both loans and lines of credit can be secured or unsecured, affecting cost and risk.

Secured Loans and Lines of Credit

Secured borrowing requires collateral, such as property, vehicles, or investments. Lower rates and higher limits are common, but defaulting can result in loss of the asset.

Unsecured Loans and Lines of Credit

Unsecured borrowing relies on creditworthiness alone. Rates are higher and limits lower, but no specific asset is at risk.

Alternative Collateral Options

Some lenders accept non-traditional collateral, including investment portfolios, cash savings, or crypto. Bitcoin-backed loans, for example, allow borrowing without selling crypto, providing liquidity while maintaining exposure to the asset. Secure platforms like Arch provide easy access to this.

When to Choose a Loan vs a Line of Credit

A loan works best when you know exactly how much you need and plan to use the funds all at once such as for a car purchase, debt consolidation, medical bill, or a home project with a firm budget. Loans offer fixed payments, a clear payoff date, and protection from rising rates, which makes them easier to budget and manage.

A line of credit is better suited for expenses that are ongoing, phased, or uncertain. It allows you to borrow only what you need, when you need it, and repay as you go, making it useful for changing costs, cash-flow gaps, or as an emergency. You pay interest only on the amount used, but variable rates, fluctuating payments, and easier access to funds require more discipline.

A good rule of thumb is to choose a loan for one-time, well-defined expenses and predictability. Choose a line of credit when you prefer flexibility, and your borrowing needs may change over time.

Comparing Costs

Borrowing cost isn’t just about the interest rate. How interest accrues, how long you carry a balance, and what fees apply often matter more.

Interest

• Loan: Interest accrues on the full amount from day one. With a fixed rate, total interest is known upfront.

• Line of credit: Interest accrues only on the amount you use. Total cost varies based on usage, timing, and rate changes.

Rates

• Loan: Typically fixed, offering protection from rising rates.

• Line of credit: Usually variable, which can lower costs initially but increase them over time.

Fees

• Loan: May include origination fees, late fees, and occasional prepayment penalties.

• Line of credit: May include annual fees, draw fees, inactivity fees, and late fees. These can accumulate even if borrowing is limited.

How to Compare Accurately

Use the annual percentage rate (APR) to compare options, since it accounts for both interest and certain fees. A line of credit often costs less when borrowing is short-term or incremental. A loan is often cheaper when you need the full amount upfront and expect to carry the balance for years.

Alternative Financing Options to Consider

Loans and lines of credit aren’t the only ways to borrow.

Credit Cards

Credit cards offer revolving access but usually carry higher interest rates. Promotional 0% APR periods can make them cost-effective if balances are paid off before the promotion ends.

Home Equity Loans vs HELOCs

Both use home equity as collateral. A home equity loan provides a lump sum with fixed payments, while a HELOC offers revolving access with variable rates. Both put your home at risk if you default.

Buy Now, Pay Later (BNPL)

BNPL splits purchases into short-term installments, often without interest if paid on time. These are best for specific purchases, not ongoing borrowing.

Asset-Backed Loans

Some lenders allow borrowing against assets such as investment portfolios, savings, or cryptocurrency. This can provide liquidity without selling assets, preserving long-term exposure.

Frequently Asked Questions

Are lines of credit the same as credit cards?

No. While both are revolving credit, lines of credit often have lower interest rates, higher limits, and defined draw and repayment periods. Credit cards typically remain open indefinitely.

Are loans always more expensive?

Not necessarily. Loans charge interest on the full amount from disbursement, while lines of credit charge interest only on what you use. However, if you need the full amount upfront and carry a balance long-term, a fixed-rate loan may cost less especially if rates rise.

Should I always choose the lowest interest rate?

No. A lower variable rate can end up costing more than a slightly higher fixed rate if rates increase or balances linger. Fees, structure, and borrowing behavior matter just as much as the rate.

Do lines of credit require perfect credit?

Unsecured lines of credit generally require stronger credit, but secured options may be available with more flexible requirements. Collateral reduces lender risk and can improve approval odds.

Can I convert a line of credit into a loan?

Not directly. They're different products requiring separate applications. However, some HELOCs offer a fixed-rate conversion feature that lets you lock a portion of your balance into a fixed-rate, loan-like structure.

Which is easier to qualify for?

Generally, loans are accessible to a wider range of borrowers. Unsecured lines of credit typically require stronger credit profiles. Secured options for either product may have more flexible requirements.

Does a line of credit affect my credit score differently?

Yes. A line of credit is revolving credit and factors into your credit utilization ratio. High utilization can lower your score. A loan is installment credit and doesn't affect utilization. Both impact your payment history equally.

Can I pay off a loan early without penalties?

Often yes, but it depends on the lender. Many personal loans have no prepayment penalties, allowing you to pay off the balance early and save on interest. Always check your loan agreement.

What happens if I don't use my line of credit?

An unused line of credit typically doesn't cost you interest, since you only pay interest on funds you draw. However, some lenders charge annual fees or inactivity fees for maintaining the account, even if you don't borrow.

Are there tax benefits to either option?

Interest on most personal loans and lines of credit isn't tax-deductible. However, interest on home equity loans and HELOCs may be deductible if the funds are used for home improvements. Consult a tax advisor for guidance specific to your situation.

Conclusion

Loans and lines of credit serve different purposes. Loans offer structure and predictability, making them well suited for one-time expenses with known costs. Lines of credit provide flexibility, allowing you to borrow only what you need as expenses arise.

Both options come in secured and unsecured forms, with trade-offs between cost, risk, and accessibility. The better choice depends on how clearly defined your borrowing needs are, how long you expect to carry a balance, and how much payment certainty you want.

About Arch

Arch is building a next-gen wealth management platform for individuals holding alternative assets. Our flagship product is the crypto-backed loan, which allows you to securely and affordably borrow against your crypto. We also offer access to bank-grade custody, trading and staking services.

Disclaimer: This article is for informational purposes only and does not constitute investment or tax advice. Cryptocurrency investments are volatile and risky. Always conduct your own research before making investment decisions.