Buying a home. Major renovations. Out-of-the-blue car repairs. These are just a few times in life when you might need to borrow money. A line of credit and a loan are two different options for borrowing money, but how do you know which one is right for you?

When deciding, it helps to understand the differences between the two options while considering your own needs, financial situation, and goals. Both give you access to funds, but they work differently. A line of credit gives you access to money up to a certain amount when you need it. You can either pay it back in full or with regular minimum payments. A loan provides you with a one-time lump sum amount and a set monthly repayment plan. 

 Let’s take a closer look at each option so you can decide what’s best for you and your situation.

What is a line of credit?

When you’re approved for a line of credit, your bank, credit union, or other financial institution gives you access to funds with a predetermined limit (credit limit) that you can use and reuse as needed. A line of credit is similar to a credit card in that it’s a form of revolving credit – that means there is no term or end date when the full amount you borrowed needs to be repaid. Compared to traditional loans and credit cards, lines of credit typically have lower interest rates, typically based on the prime rate.

You can draw as much or as little of your approved credit limit as you need. Depending upon the repayment option you are approved for, you may only have to repay the interest on the amount you borrow. You will also typically have the option to repay the amount you borrowed in full at any time.

For example, say you were approved for a line of credit with a $10,000 credit limit but only withdrew $500. If approved for the interest-only repayment option, you’d only pay interest on the $500 you borrowed and not have to repay the full amount immediately.

Also, you can access the remaining balance later (in this example, $9,500). If you repay the $500 (on top of the interest payments), your available credit will return to $10,000, which you can reuse without reapplying. Pretty flexible, huh?

Different uses for a line of credit

So, what’s a line of credit good for? Lots of things, really. The beauty of a line of credit is that it’s up to you how to use the funds. You can use them for everyday needs, a large upcoming expense, or to have peace of mind for unexpected events.

It can also be used for the following:

• A rainy-day fund: This can provide an additional safety net in addition to your emergency savings, giving you access to extra funds if you need them.

• A long-term project: Home renovations with variable costs can sometimes put you over budget. When you need the extra wiggle room for a project, a line of credit can help.

• Debt consolidation: If you’re carrying higher-interest debt from loans or credit cards, consider consolidating them with a line of credit to shrink your interest payments.

Just be mindful that this kind of access to money can be tempting. It’s important to understand that interest will apply immediately on any amount you borrow. So you’ll want to make sure you’re keeping your spending in check and only borrowing what you need so you don’t take on more debt than you can manage. 

Types of lines of credit 

A line of credit can be either unsecured or secured. 

An unsecured line of credit is — as you might’ve guessed — not backed by any security. This option is riskier to lenders, so you’ll likely have a higher interest rate compared to a secured line of credit.

A secured line of credit involves using an asset, such as a house or Guaranteed Investment Certificate (GIC), as security for the credit limit on your line of credit. Since this option poses less risk to lenders, borrowers can usually benefit from lower interest rates. However, if a borrower can’t pay back their line of credit, the lender can take possession of or enforce on the security.

Home Equity Line of Credit (HELOC)

A HELOC lets you tap into the equity you’ve built in your home to borrow funds. Since it’s a secured line of credit (your home is used as security), interest rates are typically lower, and often, credit limits are higher than for personal unsecured lines of credit. The limit you’re approved for is usually linked to the equity you have in your home and its purchase or market value. Contact your lender to see if you qualify and if this is the right option for you.

You can use the money in your HELOC to pay for home repairs and renovations, such as a new roof or your dream kitchen. Many homeowners see a HELOC as a way to invest in their home’s value. 

What is a loan?

Loans can have a fixed or variable interest rate, and interest starts immediately accruing on the total advanced amount. 

Unlike a line of credit, you'll have fixed monthly payments to pay down the principal and interest of your loan over a set time frame. Once your debt is paid off, or as you make payments on the loan, you won’t be able to access the loan again and will have to reapply for another one if you need more money.

Different uses for a loan

You can use a loan or a line of credit to fund many different things. However, with a line of credit, you usually have more freedom to choose what to use the money for, whereas loans are to be used for a specific need, such as a car or house purchase.

Types of loans

Like a line of credit, a loan can be secured (on your home or another asset) or unsecured. While there are many different types of loans, the following are some examples with specific purposes. 

Mortgages

Mortgages are secured loans from the bank or another lender that help you purchase a house, piece of land, or other real estate. (The property you’re buying serves as security for the loan). 

Before you go searching for your home, it’s a good idea to check with your bank or other mortgage lender to see how much you could be approved for. 

You have a few options when applying for a mortgage. Depending on your comfort level with potential interest rate changes during your mortgage term, you can choose between a variable or fixed rate. As for mortgage terms, banks offer a wide range of options to choose from.

To repay your loan, you’ll make regular principal and interest payments based on the terms you agree to. Then, when your mortgage term is up, you can renew your mortgage for a new term and rate or pay off the remaining balance.

Car loans

Whether it’s new or used, buying a car can be expensive. If you don’t have enough money saved up, you can get a car loan, which is a secured loan from a bank, car dealership, or another lender to help finance your purchase. Eligibility for car loans varies depending on the provider, but some basic requirements include having a driver’s licence, proof of income, and a good credit score.

Like a mortgage, you’ll have to repay the money you borrowed with regular principal and interest payments throughout your car loan term.

Student loans 

For parents and students, paying for post-secondary education can feel overwhelming, even with RESPs and other savings you might have set aside. Enter student loans. When you apply for a student loan in Canada, you’re not borrowing money from your bank but from the federal and provincial governments that work together to offer financial aid programs. Eligibility is typically based on factors like family income, tuition fees, living expenses, and whether you have any dependents.

One benefit of student loans is that they can help cover tuition, textbooks, rent, and other living expenses. Another one is that the loan is interest-free while the student is enrolled in school until six months after graduation. Once that time is up, interest starts to accrue, and you (or your student) will need to start repaying the loan. 

How to choose which option is best for you

Hopefully, at this point, you’ve gained a clearer picture of the differences between a line of credit and a loan. Now, it’s time to reflect on your own financial situation and needs to decide which borrowing option might be right for you. Here are some questions to ask yourself.

What is the money for?

If you need to borrow money for more than one purpose or want the reassurance of having access to funds for future expenses, then a line of credit may be what you’re looking for. Need the money for something more specific? You may want to consider a loan.

Do I want to have flexibility in paying back the money I owe?

With a line of credit, you’ll have to make at least your minimum monthly payments – typically the interest on what you borrowed. You’ll need to practice discipline when using and paying off a line of credit to keep your debt manageable. If you keep taking on more debt and allowing interest to accrue, it can get out of hand. A loan may be the way to go if you prefer a little more structure.

Borrowing with Tangerine

A line of credit or loan can be a smart way to borrow money, whether you need help making ends meet when times are tight or reaching some pretty important financial milestones. Each can offer lower interest rates than credit cards if you carry a balance. 

Assessing both options and what they offer relative to your needs can help you make a confident choice.

What else might help you with your decision? How about competitive rates and easy ways to pay down debt so you can continue focusing on growing your savings? That’s exactly what Tangerine offers with helpful and affordable borrowing options, including Mortgage, Home Equity Line of Credit and Line of Credit products. Learn more today.