Have you ever borrowed money? Then you may know the difference between credit and loan. Individuals, institutions, and organizations do this to care for the needs such as purchases or expenses. To achieve this, they can either take a loan or credit. Keep on reading to find out more and to decide which one is suitable for you.
Difference Between Credit And Loan
What Is Credit?
Credit is a broad term and can have different meanings depending on the area used. The general definition of credit is an agreement between two parties where one receives something valuable and agrees to pay later. The party that gets the item of value is the borrower, which is the lender. The repayment done is accompanied by interest. This term can also refer to the creditworthiness of an individual, company, or organization. How suitable they are to receive the credit, is depending on how reliable they are at repayment. In accounting, credit is the entry that decreases assets or increases liabilities in the balance sheet.
What Is A Loan?
A loan is a sum of money given from one party to another, and the borrower has to repay in total interest. The party which lends or gives out the money can be a financial institution or a bank. On the other hand, the party that receives the money can be an individual, a company, or an organization. The loan must have a principal, which is the amount of money borrowed. The interest is the additional money you have to repay, depending on the lending institution’s rates. Furthermore, it must have a term, which is the period in which you must repay the funds. This term depends on the type of loan taken.
Types Of Loan
You can broadly categorize loans as secured or unsecured. Secured loans are those with collateral that acts as the security. Unsecured loans are those whose approval relies on the credit history of the borrower. Furthermore, the following are the common types of loans and how they work.
1. Personal Loan
A personal loan is money borrowed for any purpose, such as an unexpected medical bill, buying an engagement ring, a vacation, or a new gadget. The borrower has to pay money together with interest in fixed monthly installments when the rates. However, if the bank sets the rates, they can vary. The borrower has to pay the interest in terms of the annual percentage rate. The loan’s annual percentage rate depends on the creditworthiness of the borrowers, their yearly income, and their credit score. Furthermore, the term of repayment can be between 2 to 5 years. Besides, personal loans can either be secured or unsecured.
2. Car Loan
A car loan is money borrowed to purchase a car. It is also called an automobile loan. The total loan amount includes fees and taxes.
3. Student Loan
A student loan is money borrowed to help a student access higher education. The different types of student loans include; federal loans, private loans, and refinance loans. The choice of loan to take depends on a student’s financial need, the year in school, or credit history.
4. Business Loans
These are loans issued to small, medium, or large corporations to help them run the businesses. The companies mainly repay them after five years. However, bad credit history, low cash flow, many loan applications, or lack of proper documentation can prevent an individual from securing a business loan.
Types Of Credit
The following are some of the available types of credit:
1. Bank credit
Bank credit is the amount of money borrowed from a financial institution by an individual or business to cater for car loans or mortgages.
2. Revolving credit
This credit allows an individual or business to borrow money up to a certain amount. The more you repay the outstanding balance and interests, the more you increase your borrowing chances from the same institution. You can make payment and revolve the remaining amount to the next month of payment. Credit cards and home equity lines of credit are examples of this.
3. Installment credit
In this type of credit, the lender determines the specific amount of time and month to complete the payment. The interest is also pre-calculated.
4. Consumer credit
Consumer credit is money borrowed to purchase goods or services. It is an unsecured debt on the day-to-day goods.
Differences Between Loans And Credits
- Loans are better for borrowing money for huge investments such as buying a house, car, or paying for higher education. Credits, however, are better for small unexpected expenses such as payment of office supplies or taking a home equity line of credit to pay for house renovation.
- Loans have fixed interest rates, whereas lenders offer many credits with variable interest rates. When an individual or institution takes a loan with a 4% interest rate, that rate will be constant until the loan’s total payment. However, prime rates quoted in credit institutions may keep changing. Furthermore, personal lines of credit have variable interest rates.
- Loans offer vast amounts of money to be borrowed as compared to smaller amounts provided by credit unions.
- Loans have a non-revolving credit limit where the borrower has access to the amount given once. Lines of credit, however, allow the borrowers access to the funds.
- Loans have low-interest rates compared to credit lines with high-interest rates.
- Loans have a maximum monthly repayment amount compared to the minimum monthly repayment of credits.
- Loans are primarily long-term except for payday and auto title loans. Credits, on the other, are short-term, mostly monthly.
- Loans once paid can only be applied for newly. The previous credit, however, can be recycled to borrow money.
The Bottom Line
Individuals, organizations, businesses, or companies will continually borrow funds for purchases or expenses. Therefore, don’t you think credits and loans are essential? Before a lender extends any value item, such as money, they have to consider a lot. The intended purpose, credit history, creditworthiness, and relationships with the lender are factors to consider before giving out a loan or credit.
