Is There A Difference Between Debt, Loan, and Line Of Credit?
Debt, loan, and line of credit are terms that are often used synonymously but they don’t all mean the same thing.
What is the difference between debt, a loan, and a line of credit?
Loans and lines of credits are two different types of debt. Debt is an amount of money borrowed from one party and lent to another that will be repaid at some point in the future. This may be in the form of a loan, a line of credit, or other terms the two parties agree on. Both a loan and line of credit must include who the parties are, the amount, and the terms of repayment.
The average American under 35 has $67,000 in debt according to debt.org. This is spread out over credit cards, student loans, auto loans, and mortgages. As you get older, that number only goes up. This is in part because people are buying more expensive homes. It’s only when people start retiring that their amount of debt goes down.
In summary, debt is a factor in almost everyone’s life. That is why it is so important to understand the difference between debt, loans, and lines of credit.
What Is Debt?
Debt cripples hundreds of thousands of individual’s finances every day. Debt is hard to get out of and with interest piling up each month, it only gets worse. Society pushes us to buy things we don’t need, with money we don’t have. They use psychology against us to suck us in and make bad decisions.
These are decisions that will have a negative impact for years to come and for what?
A shiny new car that you will get tired of a couple months from now?
Or a new home that you bought to impress people you don’t actually care about?
I’ve found from talking to people and through financial coaching that most people go into debt to keep up with the Jones’. In other terms, it was a bad decision for all the wrong reasons.
When thinking of lines of credit and loans, imagine debt as the umbrella that these fall under.
We’re going to discuss loans and lines of credit next but first, here is a list of resources to help you manage debt:
- Should You Pay Off A Credit Card Or Auto Loan First? How To Decide
- How to Pay Off $25,000+ in Student Loans in 5 Years!
- I Missed A Credit Card Payment Now What? – Tiller Money Saved Me!
- 7 Things You Need To Get Pre-Approved For A Mortgage FAST
What Are Loans?
When you apply for a loan, the bank does a background check. They look at all of your accounts, your credit score, and then give you terms for repayment of your loan. If approved, you are given a lump sum of money for that specific purchase.
You then get a repayment schedule that outlines every single payment you will make until the loan or debt is gone. A loan usually has a lower minimum payment, interest rate, and overall better terms than a line of credit. For the most part, you will see interest rates range from 3-7% which is considerably lower than a line of credit which I’ll show you in a minute.
The interest rates are lower for the simple reason that your chances of defaulting on a loan are generally lower than a line of credit.
What Are Lines Of Credit?
A line of credit is a form of debt but it is very different from a loan. Most of you reading this may have never even heard the term line of credit before and that is okay. In fact, it’s probably a good thing because it is something you should use cautiously.
A line of credit is an amount of money that a financial institution, usually a bank, allows you to borrow from if you need it.
The first thing that comes to most people’s minds when thinking about a line of credit is obviously a credit card. Credit cards are lines of credit. If you have a card then you have a limit on the amount you can spend on that card per month. Most will never spend up to that amount but it is still there for you.
Credit cards can be dangerous mainly due to the interest rate associated with them. Most cards range in the 15-25% area with some being even higher. This interest rate is going to vary based on the type of card and you, the borrower.
Another version of a line of credit allows you to borrow against your largest asset, your home. This is called a home equity line of credit or HELOC for short.
Borrowing against your home isn’t the only way to get a line of credit. Most banks offer them to anyone who can put something up for collateral in case you default on your payment.
The main difference between a loan and a line of credit is that you don’t get all of the money from your line of credit in a lump sum as you do with a loan. Instead, it is a revolving door of money you can borrow from whenever you need it. The most important to take away from this is to only use a line of credit if you NEED it. You can get yourself into big trouble by messing with this kind of debt.
A line of credit is still debt and by borrowing that money, you will have to pay interest to the bank in addition to any money you borrowed. That adds up quickly.
The Bottom Line
All forms of debt can be dangerous to your financial success. It doesn’t matter if it is a loan or a line of credit, when not managed properly, the consequences will stay with you for years.
Before you take out a loan, swipe that credit card, or even think about taking out a personal line of credit, make sure you are doing it for the right reason. Have a plan to repay that debt and don’t get caught in the endless cycle of paying down debt.
Your future self will thank you.
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