Consumer Lending: Loans vs Lines of Credit

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Hey Guys! Wanted to chat a little on lending. I know at times we have major things come up in life, and often times we have no idea what options we have! I am sure we all have knowledge of loans, but often times a line of credit may be more beneficial. Let us dive a little deeper into the difference and potential use. Keep in mind you have to be credit worthy in order to be eligible for any lending. Please reference Fancy Chat’s, Credit 101 to gain more knowledge on maintaining good credit.

Loan:  A thing that is borrowed, especially a sum of money that is expected to be paid back with interest.

Different Loan Types:

  • Loans can be secured or unsecured. Mortgages and car loans are secured loans, as they are both backed or secured by collateral. Loans such as credit cards and signature loans are unsecured or not backed by collateral. Unsecured loans typically have higher interest rates than secured loans, as they are riskier for the lender. With a secured loan, the lender can repossess the collateral in the case of default. However, interest rates vary wildly depending on multiple factors.
  •  Loans can also be described as revolving or term. Revolving refers to a loan that can be spent, repaid and spent again, while term refers to a loan paid off in equal monthly installments over a set period called a term. A credit card is an unsecured, revolving loan, while a home equity line of credit is a secured, revolving loan. In contrast, a car loan is a secured, term loan, and a signature loan is an unsecured, term loan.

Line of Credit: An LOC is a standing amount of money, similar to a loan, that a bank extends to a customer. A customer may draw upon the available line of credit, provided that the amount does not exceed the limit. Money borrowed on the line of credit must be paid back within a specified timeframe, at a specified interest rate. Unlike a loan, however, only the money actually drawn (or used) on a line of credit is charged interest. For instance, if someone has a $20k line of credit from his bank, but draws only $5k, he will be changed interest on only the $5k.

The most popular LOC and Loans seen in Financial institutions are Home Equity Loan/Line as well as Personal Loans. One of the benefits of having a good standing relationship with a Financial Institution is they offer better interest rates to clients.

Interest rates have a huge effect on loans. In short, loans with high interest rates have higher monthly payments or take longer to pay off than loans with low interest rates. For example, if a person borrows $5,000 on an installment or term loan with a 4.5% interest rate, he faces a monthly payment of $93.22 for the next five years. In contrast, if the interest rate is 9%, the payments climb to $103.79.

Similarly, if a person owes $10,000 on a credit card with a 6% interest rate and he pays $200 each month, it will take him 58 months or nearly five years to pay off the balance. With a 20% interest rate, the same balance and the same $200 monthly payments, it will take 108 months or nine years to pay off the card.

 

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