Line of Credit vs. Credit Card

Jack Prenter, Founder of Dollarwise

When it comes to managing expenses and handling unforeseen costs, two common choices Canadians often consider are lines of credit and credit cards. Both serve as essential financial tools, yet their structures and functionalities differ significantly.

Credit cards offer convenience and immediate access to funds. They come with preset spending limits, allowing users to make purchases, earn rewards, and pay off balances monthly or over time.

On the other hand, a line of credit provides a predetermined credit limit, offering flexibility in borrowing and repaying, akin to a loan linked to a bank account.

In this line of credit vs. credit card comparison article, we’ll delve into the specifics of these two credit options to help you make smart financial decisions. 

What is a line of credit?

A line of credit (LOC) is a flexible borrowing option provided by banks or credit unions. It allows individuals to access funds up to a predetermined limit, similar to a credit card but with a different operational structure.

The basic concept behind a line of credit involves having a maximum borrowing amount approved by the lender.

Unlike a conventional loan where the borrower receives a lump sum upfront, an LOC grants the flexibility to withdraw funds as needed, up to the approved limit. Interest accrues only on the amount borrowed and used, not the entire credit limit.

Types of lines of credit

Lines of credit come in various forms, each tailored to specific needs and financial situations. Understanding the different types helps individuals align their borrowing needs with the most suitable option. Here are some common types of lines of credit:

Personal Line of Credit (PLOC):

Personal Line of Credit (PLOC)

Example of what you get with a PLOC. (Source: TD)

This type of line of credit is unsecured, meaning it doesn’t require collateral. It’s based on the borrower’s creditworthiness and financial history. PLOCs often offer flexibility in terms of borrowing limits and repayment options.

Home Equity Line of Credit (HELOC):

Home Equity Line of Credit (HELOC)

Example of what you get with a HELOC. (Source: Tangerine)

Secured by the equity in one’s home, a HELOC allows homeowners to borrow against the value of their property. It offers a revolving line of credit, typically with lower interest rates compared to other forms of credit. HELOCs are often used for major expenses like home renovations or education costs.

Business Line of Credit:

Business Line of Credit

Features of CIBC business lines of credit. (Source: CIBC)

Aimed at small businesses or entrepreneurs, this type of LOC provides access to funds for operational expenses, inventory purchases, or managing cash flow. It helps cover short-term financial needs and can be crucial for sustaining business operations.

Secured Line of Credit:

Similar to a HELOC, a secured line of credit requires collateral, such as property or investments, to secure the credit. By using collateral, borrowers may access higher credit limits or more favorable interest rates.

Student Line of Credit:

Student Line of Credit

RBC, for example, offers 3 primary types of student lines of credit. (Source: RBC)

Specifically designed for students pursuing higher education, this line of credit assists with tuition fees, textbooks, and other educational expenses. It often involves competitive interest rates and flexible repayment options.

Typical use cases and advantages

This type of credit is often used for various purposes, such as handling unexpected expenses, managing cash flow, making home improvements, or covering educational costs.

You can access the funds through a couple of means, such as:

  • Withdrawing money from an ATM
  • Writing a cheque
  • Using phone, mobile, or online banking to transfer the line of credit funds to your chequing account
  • Using your account to pay off bills

Interest rates and repayment terms

One primary characteristic of a line of credit is its revolving nature. As the borrowed amount is repaid, the available credit replenishes, ready for future use. Additionally, repayment terms vary, ranging from interest-only payments to paying down the principal balance. 

The interest rates for lines of credit can be variable or fixed, depending on the agreement with the lender and the current market conditions.

Key differences between lines of credit and credit cards

While these two credit options may sound similar, there are a few vital differences that you need to understand before settling on one option. 

FeatureCredit CardsLines of Credit
Accessing & Using Funds– Online transactions
– In-person
– ATM
– Online banking
– Cheque
ATM
Online banking
Cheque
Potential Usage Fees– Annual fees
– Late payment fees
– Cash advance fees
– Foreign exchange fees
Administrative or registration fees
Annual or monthly maintenance fees
Interest– Variable rate (generally around 19%)
– Interest is accrued by not paying the bill in full on a monthly basis
– 21-day grace periods are common
Lender’s prime rate + a set percentage
Interest is accrued from when you borrow the money until you repay it in full
Rewards– Reward points
– Cash back
– Sign-up bonuses
None
Credit History ContributionYesYes
Insurance Coverage– Purchase protection
– Extended warranty
– Car rental insurance
– Travel insurance
None
Minimum Payments– 1-3% (or 4% for Quebec residents)
– Fixed amount (usually $10-$20)
2% (usually)
$50 (usually)

Benefits and drawbacks of LOCs and credit cards

LOCs

Benefits:

  • Are available for anything you want
  • Lower interest rates than personal loans or credit cards
  • Apply once and gain access to the funds whenever you want
  • Can be used to avoid overdraft fees and other fees in your chequing account

Drawbacks:

  • Making only minimum payments can drastically prolong the repayment period
  • Lenders can change interest rates at any time
  • Interest rates vary a lot between lenders
  • Having easy access to money can lead to overspending and financial issues in the future

Credit cards

Benefits: 

  • Sometimes come with insurance coverage
  • Can generally earn rewards by spending funds or opening an account
  • Can be used for online and in-person transactions

Drawbacks:

  • Fees are very common (sometimes multiple)
  • Higher interest rates than LOCs

Line of credit vs. credit card: What is the right option for your needs?

When it comes to choosing between a line of credit and a credit card, making the right decision hinges on various factors. Understanding your financial circumstances, credit requirements, and the purpose of borrowing is crucial in determining which option aligns best with your needs.

Evaluate Personal Financial Situation & Credit Needs: 

  • Line of Credit: Ideal for larger, one-time expenses or ongoing financial needs with the flexibility to borrow as needed within a set limit.
  • Credit Card: Suited for everyday purchases, smaller expenses, and earning rewards or cashback benefits.

Financial Health & Credit Score Impact: 

  • Line of Credit: Responsible management can positively impact credit scores due to its structured repayment terms.
  • Credit Card: Timely payments and lower credit utilization can positively impact credit scores.


Credit Utilization Ratios Impact of Each Option: 

  • Line of Credit: Utilization typically has a lower impact as interest accrues only on the borrowed amount.
  • Credit Card: Higher utilization can negatively affect credit scores, impacting future borrowing ability.

Hidden Costs & Fees: 

  • Line of Credit: May have fewer upfront fees but might incur interest on borrowed amounts.
  • Credit Card: Annual fees, interest charges on outstanding balances, and additional fees for cash advances or foreign transactions can apply.

Special Features: 

  • Line of Credit: Flexibility in borrowing, often lower interest rates compared to credit cards.
  • Credit Card: Rewards programs, cashback offers, and additional perks like travel insurance or purchase protection.

Now that you know which features to compare, it’s time to learn which strategies to employ to make the best possible financial decision for your needs.

  1. Assess Purpose: Determine the reason for borrowing – whether it’s for specific large expenses or daily spending needs.
  2. Evaluate Repayment Strategy: Consider how you plan to repay borrowed amounts, whether in lump sums or through regular installments.
  3. Compare Costs: Analyze the interest rates, fees, and potential hidden costs associated with both options.
  4. Consider Credit Impact: Understand how your choice may affect your credit score and borrowing ability in the future.

Review Additional Features: Compare the value of perks or benefits offered by each option and how they align with your lifestyle and needs.

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