Credit Cards vs. Lines of Credit

Credit cards and lines of credit (LOCs) are two common and popularly used financial solutions that let customers gain access to borrowed funds. Both of these credit types are known for the flexibility that they offer, their repayment structure, and usage. Understanding the difference between the two can help individuals choose a suitable option based on their financial needs.

A line of credit is a flexible borrowing option that lets users gain access to funds up to a pre-approved limit. The borrower can withdraw as much as they require from this line of credit and either choose to repay it partially or fully. Interest is charged on the amount being utilised. Lines of credit are most commonly used by businesses to manage their cash flow, unexpected expenses, or any large purchases.

On the other hand, a credit card is a payment solution that lets customers make purchases up to a predetermined credit limit. Unlike a line of credit, a credit card is designed for making transactions instead of withdrawals. You can choose to pay the minimum amount due every month (with interest applying to any outstanding balance) or pay the balance in full.

Here are the key differences between a credit card and a line of credit that you should know about before applying:

A credit card works by letting users make transactions up to the predetermined limit. If the outstanding balance of your credit card is not paid in full by the due date, then interest is charged. Additionally, credit cards offer a grace period, during which you can make purchases and clear the balance within this period to avoid any interest. Credit cards are known for their benefits, such as rewards, cashback, and discounts.

A line of credit provides funds that can be withdrawn by the customer at any given time, based on the borrower's needs. Interest is charged only on the funds that has been utilised, and upon repaying the amount used, the available credit limit is restored. This payment solution makes it useful for tackling unforeseen expenses or large purchases.

Both credit cards and lines of credit have a significant impact on credit scores based on the borrower's financial behaviour, credit utilisation, and repayment history.

Repayment History

Making timely payments helps improve your credit score, while missing payments has a negative impact. Ensure that you pay your outstanding dues on time to maintain a good credit score.

Credit Utilisation Ratio

A credit utilisation ratio above 30% can have a negative impact on your credit score. Keeping credit utilisation below 30% is considered favourable, as it shows lenders that you are responsible with credit and not in financial distress.

Credit Account Age

An older credit account can help improve your credit score. This demonstrates a longer borrowing history and responsible credit behaviour.

Choosing between a personal line of credit and a credit card depends on the type of expense that you are trying to tackle and your financial need. Here are situations where one may be more suitable than the other:

Regular Spending

A credit card is ideal for everyday usage, online transactions, and paying bills. However, a line of credit is not designed for frequent spending, which makes it better suited for large unforeseen expenses.

Large Expenses

Credit cards may have a higher interest rate and a lower limit in comparison, making them impractical for high-value purchases. A line of credit offers a lower interest rate and may provide flexibility in the credit limit for big-ticket purchases.

Cash Withdrawals

Making cash withdrawals with a credit card can be expensive due to the higher fees and interest rates. A line of credit, on the other hand, offers a cost-effective way to access funds in case of an emergency.

Long-term Borrowing

The cost of borrowing on a credit card for the long term makes it expensive for extended repayment periods. A line of credit is more affordable for long-term borrowing, as interest applies only to the amount utilised.

Here are the advantages and disadvantages of a line of credit and a credit card to help you make an informed decision:

Advantages of a Credit Card

• Accepted for both online and offline transactions, eliminating the need for cash

• Most cards offer reward points, cashback, and discounts on transactions made

• No interest is charged if the outstanding balance is paid in full within the billing cycle

• Making regular and timely payments can help improve your credit score

• A credit card provides borrowers with fraud protection, buyer’s insurance, and some issuers may even provide extended warranties

Disadvantages of a Credit Card

• The interest rate on an outstanding balance that remains unpaid can go up to 45%

• Withdrawals at an ATM attract very high processing fees and interest is charged immediately

• Easy access to credit may lead to irresponsible spending habits and unnecessary debt

• A high credit utilisation ratio can lower your credit score if spending is not controlled 

Advantages of a Line of Credit

• A line of credit is considered more affordable than credit cards for large expenses and for long-term borrowing due to its lower interest rates

• With a line of credit, you can withdraw funds as and when needed, based on your requirement

• Interest is charged only on the amount that you use, not on the entire credit limit

• Some lines of credit issuers may even allow a fixed repayment schedule

• This form of credit is ideal for managing unexpected expenses such as urgent repairs, medical bills, or big-ticket expenses

Disadvantages of a Line of Credit

• Requires a strong credit score and proof of a steady income, along with other strict eligibility criteria, making it harder to qualify

• Unlike credit cards, a line of credit does not offer any rewards, cashback, or benefits on purchases

• Continuous access to credit may lead to long-term debt accumulation

• Some lenders may charge an annual non-usage fee, which increases the cost of keeping a line of credit active