Line of Credit vs Traditional Loans: Pros and Cons Explained

When you need money for major expenses, emergencies, or long-term goals, you normally think of two main options: unsecured loans, such as a traditional loan or a line of credit. Both can help you get funds quickly; however, they do so in very different ways. With a traditional loan, you get a certain amount of money up front. However, with a line of credit, you can borrow as much as you need but only up to a certain amount.

In this guide, we'll discuss how a line of credit varies from a traditional loan. We will also learn about the main pros and cons of each to help you choose the best one for your financial situation.

What is a Line of Credit?

A Line of Credit (LOC) is a flexible loan provided by a bank or financial institution that gives you continuous access to funds up to a preset borrowing limit. You can borrow money as needed, repay the borrowed amount, and borrow again, as long as you stay within your approved limit.

A line of credit is like a credit card; however, it usually has lower interest rates compared to other forms of credit. You only have to pay interest on the amount you actually use, not on the entire credit limit.

Here's a line of credit example:

• Your lender offers you a ₹3,00,000 personal line of credit.

• You withdraw/use ₹50,000 for an unexpected expense.

• You repay ₹10,000 in the next month.

• You can again use that ₹10,000 in your draw period.

A credit line is ideal for borrowers with irregular income or those who need to pay for expenses regularly, as it is truly flexible.

What is a Traditional Loan?

An instalment loan, such as a traditional loan (e.g., a Car Loan or a Personal Loan), provides you with a particular sum of money as a lump sum. You can pay back the whole amount in fixed monthly instalments over a specified repayment period.

Most loans carry fixed interest rates; therefore, your instalment and interest amount will remain the same every month. However, in this loan, you cannot reuse the funds after repaying them.

For instance, if you avail of a Personal Loan of ₹5,00,000, you'll receive the amount in full once approved. Then, you'll have to repay it through EMIs until your outstanding balance is zero.

Line of Credit vs Loan Difference

Here’s a table to help you understand better:

Feature	Line of Credit	Traditional Loan
Funds Access	Flexible and reusable	One-time lump sum
Interest Charges	Charged only on the used amount	Charged on the entire amount
Repayment	Variable, based on usage	Fixed EMIs
Interest Rates	Often variable	Usually fixed
Borrowing Limit	Reusable within the approved credit limit	Not reusable once repaid
Ideal For	Emergency funds, irregular income	Planned, fixed expenses

Pros of a Line of Credit

Here are some of the main pros of a line of credit:

1. Flexibility

You can access funds anytime during the draw period, making it ideal for ongoing expenses or irregular income plans.

2. Pay Interest Only on What You Use

Unlike traditional loans, where interest is charged on the full amount and can lead to higher interest rates, a line of credit charges interest only on the amount you actually use.

3. Revolving Credit

Once you repay the borrowed amount, you can use it again. This revolving feature helps in managing emergency funds or regular expenses efficiently.

4. No Need to Reapply

You don’t have to reapply for a new loan every time you need funds; you can withdraw from your existing credit limit.

5. Better Financial Planning

Since you withdraw money only when needed, it helps you manage cash flow and avoid unnecessary borrowing.

Cons of a Line of Credit

Although a line of credit is one of the most flexible financing options, here are some cons that you should consider:

1. Variable Interest Rates

Most lines of credit come with variable interest rates that may increase over time, making your interest payments unpredictable.

2. Temptation to Overspend

Having continuous access to funds can lead to overspending or borrowing more than you actually need.

3. Fees and Charges

Some lenders may charge application fees, annual fees, or closing costs for a line of credit, which add to your overall borrowing expense.

4. Impact on Credit Score

Missing or delaying payments can negatively affect your credit report and lower your credit score.

5. No Withdrawals After Draw Period Ends

Once the draw period ends, you can no longer withdraw funds and must start repaying the outstanding balance.

Pros of Traditional Loans

Here are the key advantages of traditional loans, such as Personal Loans (also known as secured loans):

1. Fixed Payments

With fixed interest rates, you will be able to know exactly how much you need to pay each month. This is helpful for your ongoing budgeting.

2. Lump Sum Amount

You can receive the lump sum amount in one go; therefore, it's ideal for one-time purchases, such as purchasing a car or for medical emergencies.

3. Less Temptation to Overspend

Since you receive a fixed lump sum, you’re less likely to overspend compared to a revolving credit line.

4. Easy Repayment Schedule

Repayment is straightforward with fixed EMIs and clear schedules, making budgeting easier.

5. Improves Credit Score (if repaid on time)

Consistent and timely EMI payments can help boost your credit score and strengthen your credit history.

Cons of Traditional Loans

Here are some of the cons associated with traditional loans:

1. Limited Flexibility

Once you’ve repaid the loan, you can’t reuse the funds. If you need more money, you’ll have to apply for a new loan.

2. Interest on the Full Amount

You begin paying interest on the entire loan amount from day one, even if you don’t use all the funds immediately.

3. Prepayment Penalties

Some lenders may charge fees for early repayment or prepayment of the loan.

4. Lengthy Application Process

Applying for a loan may involve credit checks, extensive documentation, and waiting periods for approval.

5. Costly for Short-Term Needs

If your requirement is short-term, paying interest on the full amount can make the loan more expensive.

To Conclude

A traditional loan and a line of credit are two common financing options for people looking to borrow money; however, they work in very different ways. A line of credit provides a revolving credit limit that you can use as needed. Also, the interest is charged only on the amount you borrow. In contrast, a traditional loan gives you the full loan amount upfront, and interest starts accruing from day one.

Need Quick Funds? Poonawalla Fincorp offers Personal Loans with instant approval, flexible EMIs, and quick disbursal. Apply now for your loan and fulfil your financial needs today!

FAQs

Can I turn my current Personal Loan into a line of credit?

No, you can't turn it directly. You'll have to apply independently for a personal line of credit with your lending institution.

Does a line of credit impact my credit score if I don't use it?

No, simply having a line of credit does not affect your credit score. Your credit score is impacted only if you borrow from the line, make late payments, or exceed your limit.

Can I use a line of credit for debt consolidation?

Yes, you can consolidate debt using a personal line of credit, especially if the interest rate is lower than your existing debts.

Can I use a line of credit for business and personal expenses together?

Most lenders don’t have a minimum withdrawal requirement, so you can borrow only the amount you need from your line of credit.

How is a line of credit different from a credit card?

Both are revolving credit options. However, a line of credit usually offers lower interest rates, higher borrowing limits, and more flexible repayment terms compared to a credit card.