Line of Credit vs Credit Cards – What’s The Best Option Now?
In every Canadian’s life, there’s a high chance of needing to borrow money. Be it for a mortgage, a personal line of credit, or a credit card, most of us will face debt at some point.
However, the levels of debt and the type of debt you can go into are quite expansive. For this reason, many Canadians get confused and don’t understand what type of product they should utilize. In this article, we’ll compare credit cards to lines of credit.
A line of credit vs a credit card
Credit cards offer convenient access to a revolving line of credit with a set limit and are typically used for everyday purchases or short-term financing needs. They come with the ability to earn rewards, protection on purchases, and the convenience of widespread acceptance.
On the other hand, a line of credit is a more flexible borrowing option that can provide a higher credit limit than a standard credit card. It’s generally used for larger expenses or to manage cash flow.
Lines of credit often have lower interest rates compared to credit cards, making them a cost-effective choice for long-term borrowing. However, they lack the rewards and protections that credit cards may offer.
Interest rates and fee differences
These are the two most important elements between the two products, and it’s critical that you understand the differences between the two as it can end up saving you thousands of dollars in interest and fees.
Credit card interest rates
Credit card companies often charge variable interest rates. Rates are typically stated as an annual rate known as the Annual Percentage Rate (APR), which can fluctuate based on the prime rate plus a margin.
For purchases, if the cardholder does not pay the full balance by the due date, interest is charged on the remaining balance. Cash advances usually attract a higher APR and are charged interest immediately, with no grace period.
Line of credit interest rates
Unlike credit cards, lines of credit commonly offer lower interest rates, which are frequently given as the prime rate plus a certain percentage.
One of the key differences is that interest accrues daily on the amount borrowed from the day of withdrawal until it’s fully repaid. With a line of credit, interest is immediate. With a credit card purchase, outside of a cash advance, you typically have a month to pay the balance off before interest accrues.
Credit card fees
Credit cards can have a range of fees, including an annual fee, late payment fees, and charges for transactions such as cash advances.
However, they don’t always have an annual fee. Typically, you’ll see credit cards charge an annual fee when they offer some sort of high-quality rewards system. In this day and age, an annual fee for a normal credit card really wouldn’t go over well.
Historically, I’ve been able to get my annual fee waived on my credit card by simply calling in and asking for it to be waived.
Line of credit fees
Generally, there are no annual fees associated with a line of credit, but some may have administrative fees or charges for transactions. In addition to this, your bank may choose to charge you a monthly fee to keep the line of credit open, much like a bank account.
However, if you’re paying a fee on your line of credit, I’d look elsewhere. Many institutions are having to cut fees to compete with cheaper online banks that are offering outstanding products at rock-bottom fees.
Overall, lines of credit are usually preferred for their more favourable interest rates, especially for larger or longer-term borrowing needs.
Credit limits and loan amounts
Generally, line of credits carry larger limits than a credit card. However, credit cards often come with an easier approval process. Lets go over some intricacies of both.
Credit card limitations
Credit card companies assign a credit limit, which caps the total amount of money that a cardholder is authorized to borrow. This limit is based on numerous factors, including an individual’s credit score, income, and past credit history.
Limits can vary significantly, from a few hundred to tens of thousands of dollars. Cardholders seeking to increase their credit limit can often do so by proving their creditworthiness over time through responsible usage and timely payments.
If you own a credit card, you will often have your bank or issuing institution constantly nagging you to upgrade your credit card limit if you’ve proven worthy of paying it off.
Line of credit limitations
A line of credit typically offers higher borrowing capacities compared to credit cards, which makes them more suitable for larger, long-term financial needs.
In addition to this, if you open up a Home Equity Line of Credit (HELOC) your borrowing capacity will typically be a particular percentage of the equity of your home, as you are putting your home up for collateral.
As a result of this collateral, HELOCs generally offer lower interest rates than unsecured lines of credit.
Upon approval, individuals can borrow money up to a pre-approved limit and pay interest only on the amount used, not on the entire line of credit available to them. This can lead to more flexibility and often lower costs if utilized correctly.
Is it easier to be approved for a line of credit or credit card?
Approval for a line of credit or loan generally hinges on one’s credit score and financial history. Lenders may view lines of credit as higher risk, given their larger amounts and more flexible borrowing terms, which can make them harder to qualify for than credit cards.
However, individuals with a good credit score and reliable income are often more likely to be approved for both forms of credit.
Accessing funds and repayment terms
When you’re debating between taking out a new credit card or seeking out a line of credit, fund accessibility is pretty important. While both are certainly convenient, from a retail standpoint a credit card is likely to be more convenient.
In addition to this, both of these borrowing options have very different repayment structures. Lets go over both situations.
Credit card accessibility
Credit cards provide an immediate source of funds, conveniently accessed for daily transactions. Individuals may use them virtually anywhere, including online and at retail locations.
Cash can be withdrawn using a credit card at an ATM, but this often comes with significant fees. For direct transfers or large, immediate expenses, credit cards might not be as accommodating as a line of credit.
Line of credit accessibility
Lines of credit are often a bit trickier to access. Although you can get a card for a line of credit, in some situations it would require a transfer of funds from your line of credit to your chequing or savings account, and from there you could spend the funds.
However, lines of credit allow for flexible borrowing, including the ability to write cheques or transfer funds directly to a bank account. This flexibility can be especially valuable for covering larger expenses or consolidating debts.
Credit card repayment
You’ll find most credit cards offer a pretty standardized repayment system. You’ll have to cover a minimum percentage of the balance with your monthly payments, and in some situations any excess fees or interest over that time period.
Credit cards are designed for minimum payments to take an exceptionally long time to eliminate the balance. I’ve even witnessed some be as long as 20 years.
Repayment with a line of credit
I’ve seen lines of credit work in numerous ways. Some will force you to pay back the interest accrued plus a particular portion of the principal. However, for many lines of credit, all you have to do is pay back the interest accumulated.
This can help you out in a tight situation, as your minimum payments will be smaller. However, it’s important to keep in mind that you are paying back none of the principal, which will increase the amount of money you have to pay to reduce the loan.
Lines of credit can be a cost-effective borrowing solution, as they typically offer lower interest rates on borrowed funds than credit cards, and the repayment options are more flexible.
Rewards and incentives
When comparing credit cards and lines of credit, one should consider how rewards and incentives vary between these financial products.
Credit cards often offer an array of rewards that can be earned through their use, while lines of credit typically don’t, they more so focus on providing a lower rate of interest and more flexibility.
Credit card perks
Credit cards are renowned for their rewards programs, offering incentives such as cash back, points, and travel perks. Users can accumulate points for each dollar spent, which can then be redeemed for a range of options, from merchandise to travel.
Cash back rewards return a percentage of total spending back to the cardholder, effectively discounting purchases. Most credit cards also offer a grace period, allowing cardholders to avoid interest charges by paying off their balance within this time.
The one thing that quickly eliminates any sort of benefits from credit card perks is carrying a balance. Typically you will pay anywhere from 20%-25% interest on a credit card, while most offer cash back in the realm of 1-3%. Even carrying a interest accruing balance for a couple weeks negates all benefits of cash back rewards.
The credit card system is designed intentionally for this. Make sure if you’re getting a credit card for the points, you are not carrying a balance.
Line of credit benefits
In contrast, a line of credit doesn’t typically offer points or cash back. This isn’t always the case. For example, I have a business line of credit that allows me to collect points. But this is a rarity, and most products won’t have this ability.
However, they provide benefits in the form of potentially lower interest rates and the flexibility to borrow exactly what you need up to the limit. A major benefit is that users only pay interest on the money they actually withdraw, which can be preferable for those financing large, long-term expenses.
The impact of a line of credit and credit card on your credit rating
Both lines of credit and credit cards have implications for an individual’s credit score and debt levels. Paying it back on time and using it responsibly can improve your credit score, while the opposite can destroy it.
Both a credit card and a line of credit are virtually the same in terms of impact to your credit, so I’ll speak on both here.
Credit score influence
A line of credit and a credit card both play a role in an individual’s credit history. Regular payment on either can have a positive effect on a credit score, demonstrating to lenders that an individual is a reliable borrower. Conversely, missed payments, high utilization rates, or defaulting can negatively impact one’s score.
Debt management
Credit cards often have higher interest rates compared to lines of credit, which can make debt management more challenging for cardholders.
Conversely, lines of credit typically offer lower rates, representing a more cost-effective option for managing larger debts over time.
Many borrowers will utilize lines of credit to pay down credit cards so they can reduce their overall interest burden. If you can, simply pay off the credit card. However, if you’re unable to, consolidating your debt into a lower level of interest has proven to help people eliminate debt.
Does paying off a line of credit help your credit score?
Paying off a line of credit can improve a credit score, as it reduces the individual’s credit utilization rate—a key factor in credit scoring. It also shows financial responsibility and the ability to manage and repay borrowed funds.
Does closing down my line of credit hurt my credit score?
Closing a line of credit can hurt a credit score if it increases the individual’s overall credit utilization ratio or reduces the age of their credit accounts. However, the impact varies based on the person’s overall credit profile and debt situation.
What about having more lines of credit or credit cards, does that improve my score?
Having multiple lines of credit may potentially improve a credit score, if they are managed responsibly. They can demonstrate to financial institutions that an individual can handle various credit accounts, but this may be counterproductive if it leads to high levels of debt.
What if I have a line of credit or credit card but never use it?
Having a line of credit or credit card and not using it can be beneficial for one’s credit score as it keeps the credit utilization rate low. However, financial institutions may eventually close an inactive account, which could impact the length of credit history and credit mix factors in the credit score calculation.
So what should you get, a line of credit or a credit card?
Lets look over the main benefits and downfalls of each so that you can ultimately weigh your options and choose the best product for you.
The pros of a line of credit
- Typically a lower rate of interest
- Larger approval limits
- Flexible repayment options
The cons of a line of credit
- Less flexibility in terms of fund access
- Generally do not offer perks or cash backrewards
- Typically much harder to get approved for
The pros of a credit card
- Very flexible in terms of fund access
- Easy to get approved for
- Some come with benefits and cash backrewards
- Offer consumer protection in the event of fraud
The cons of a credit card
- Very high rates of interest
- Some have annual fees
When a credit card could make sense
For daily expenses such as groceries or dining out, credit cards are more practical due to ease of use and potential rewards. Because a lot of lines of credit don’t come with a card to make purchases in a retail store or online, they’re not very functional when it comes to every day spending.
When a line of credit could make sense
Lines of credit, on the other hand, are more suitable for large purchases or investments that can’t be readily financed through savings.
Think of purchasing a new washer or dryer set, refrigerator, home improvements, or even building a deck. Some businesses you work with in this regard, particularly contractors, won’t even accept a credit card because of their high transaction fees. So for this reason, you may need to utilize a line of credit.