Loans and credits are two different types of financing. Both are banking products that provide capital to borrowers, but their definitions and objectives differ.
While a loan provides all of the money requested at the time it is issued, credit provides the customer with an amount of money that can be used as needed, using the entire amount borrowed, a portion of it, or none at all.
What is a Loan?
A loan is a financial product that allows a user to obtain a fixed amount of money at the start of the transaction on the condition that this amount, plus the agreed-upon interest, be returned within a specified time frame. The loan must be repaid in monthly installments.
The following are the primary characteristics of a financial loan:
- The transaction has an expiration date.
- Once all of the capital has been repaid through installment payments (monthly, quarterly, half-yearly, and such), the operation is completed, with no further funds available unless a new loan is arranged.
- The total amount borrowed is subject to interest charges.
- Loans are for a longer period of time, usually years.
- The amount of a loan is determined by the borrower's need and creditworthiness.
- Loans are of two types - secured and unsecured.
- Secured loans are backed by some form of collateral, which is usually the same asset that is used to secure the loan. A car loan, for example, is secured by the vehicle. If the borrower fails to meet their financial obligations and defaults on the loan, the lender has the right to repossess the vehicle, sell it, and apply the proceeds to the remaining loan balance.
- Unsecured loans, on the other hand, do not have any form of collateral backing them up. Most of the time, approval for these loans is based solely on a borrower's credit history, and they are typically advanced for lower amounts and at higher interest rates than secured loans.
What is Credit?
A credit is a more adaptable type of financing that allows you to access the amount of money loaned based on your needs at any given time. The credit establishes a maximum amount of money that the customer may use in part or in full.
The customer may use the entire amount of money provided, a portion of it, or none at all.
Let us take a look at the main characteristics of a credit that set it apart from a loan:
- The interest rate on a credit card is usually higher than the interest rate on a loan.
- Although interest is only paid on the amount used, a minimum fee may be charged on the undrawn balance.
- More money will become available as the money is returned, as long as the limit is not exceeded.
- When a borrower is approved for a line of credit, the bank or financial institution advances them a set credit limit that they can use in full or in part over and over again. This converts it to a revolving credit limit, which is a much more versatile borrowing tool.
- Credit lines, unlike loans, can be used for any purpose, from everyday purchases to special needs such as trips, minor renovations, or debt consolidation.
A person's credit line functions similarly to a credit card and, in some cases, a checking account. Individuals can access these funds whenever they need them, just like a credit card, as long as the account is current and there is credit available to use.
So, if you have a credit line with a $10,000 limit, you can use some or all of it to meet your needs. If you have a $5,000 balance, you can use the remaining $5,000 whenever you want. If you pay off the $5,000, you will have access to the entire $10,000 again.
In comparison to loans, credit lines have higher interest rates, smaller dollar amounts, and lower minimum payment amounts. Payments are made on a monthly basis and include both principal and interest.
Lines of credit typically have a more immediate and significant impact on consumer credit reports and credit scores. Interest does not begin to accumulate until you make a purchase or withdraw cash from your credit line.
Unlike a loan, credit is typically renewed each year to allow the customer to continue to use this credit facility as needed.
Credit cards and credit facilities, which are generally arranged through a current account in which deposits and withdrawals can be made up to the agreed limit, are the most common ways to obtain finance through credit.
What is the Difference Between a Term Loan and Cash Credit?
If the loan proceeds are used to purchase an asset, the useful life of that asset may have an impact on the repayment schedule. To reduce the risk of default or failure to make payments, the loan requires collateral and a rigorous approval process.
However, if a term loan is paid off ahead of schedule, there are usually no penalties.
Term loans are available in a variety of lengths, which usually correspond to the loan's lifespan.
- A short-term loan is typically offered to businesses that do not qualify for a line of credit and lasts less than a year, though it can also refer to a loan of up to 18 months.
- An intermediate-term loan typically has a term of more than one year but less than three years and is repaid in monthly installments from a company's cash flow.
- A long-term loan has a term of three to 25 years, is secured by company assets, and requires monthly or quarterly payments from profits or cash flow. The loan restricts the company's other financial commitments, such as other debts, dividends, or principals' salaries, and may require a portion of profit set aside for loan repayment.
