The Difference between loans, lines of credit, and a credit card

If you need to purchase something but you don’t have the money available to cover it, there are a few types of financing options available: loans, lines of credit and credit cards. It’s important to understand the difference between these three options to decide which one is right for your situation.

Loans

When a lender approves you for a loan, they issue you a lump sum of money and you pay it off in payments. Loan amounts can range considerably from hundreds of dollars to millions. While monthly payments are most common, loans may have other payment frequencies.

The advantage of a loan is that you get the money upfront and you have set payments that you can make to pay it off in full. The disadvantage is that you’re only getting that initial payment, whereas lines of credit and credit cards allow you to spend up to your credit limit.

Lines of Credit

With a line of credit, the lender assigns you a credit limit. You can use that line of credit to make purchases, or you can withdraw it as cash. The credit limit is the maximum amount you can borrow from the lender, but if you borrow from your line of credit and then pay it back, you can borrow more.

For example, let’s say you have a $10,000 line of credit and you borrow $5,000 in cash. You still have another $5,000 you can borrow, but if you pay back $3,000, you’ll then have $8,000 available.

Lines of credit are more versatile than loans and tend to have lower interest rates than credit cards. However, they’re also more difficult to obtain, and unlike with credit cards, there’s no grace period regarding when the lender starts charging you interest on purchases.

Credit Cards

Credit cards work similarly to lines of credit, although they’re much easier to obtain. You have a credit limit, and you can put up to that amount on your credit card. When you pay your bill, your available credit goes up again.

Credit cards usually have higher interest rates than lines of credit or loans. They do have grace periods, though, and if you pay purchases off within the grace period, you won’t need to pay any interest. Another benefit of credit cards are that many of them earn reward points or cashback on your purchase, and you can actually get a return on your spending.

Besides the higher interest rates, the main disadvantage of credit cards is that you can’t get cash with them like you can with a loan or a line of credit. You can get a cash advance, but these carry high fees.

Avoid Financing When You Can

Whenever possible, you’re better off avoiding financing options entirely and instead paying for purchases upfront to avoid interest. Now, using a credit card that earns rewards or cashback is a smart move if you pay it off in full every month, because you’ll end up making money from your spending without paying any interest.

What should you do if you need money for a purchase? Here are 5 ways to make money fast:
• Sell items through eBay, Craigslist, yard sales or other methods
• Rent out a room or even the couch in your home through Airbnb or other home-sharing platforms
• Sign up with a ride-sharing service as a driver
• Sign up with a delivery service, such as Postmates, as a delivery driver
• Give private lessons in a skill you have, such as a foreign language or a musical instrument

Of course, there are some situations where you’ll need financing. For large purchases, a loan is the traditional option and tends to be the best choice. If you need more flexibility, lines of credit and credit cards can both work well. Compare each and consider what you need the money for to decide which is right for you.

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