Money Talks: The difference between line of credit and credit card

When it comes to managing personal finances, having access to credit can be a valuable tool. Two common forms of credit that Canadians often use are lines of credit and credit cards. Understanding the differences between these two credit products, as well as their advantages and drawbacks, can help you make informed decisions and use them responsibly. In this article, we will explore the characteristics, costs, convenience, rewards programs, and responsible usage of lines of credit and credit cards.

What is a line of credit?

A line of credit is a flexible borrowing option that provides you with access to funds up to a pre-set limit. It functions similarly to a personal loan, where you can borrow credit immediately and repay money as needed within the approved credit limit. Lines of credit can be a secured line or unsecured line, with the former requiring collateral such as a home or an investment account and are available through your bank or credit union.

Do you pay interest on a line of credit?

Now, you're probably wondering, "How does interest work on a line of credit? Do you even need to pay interest on a line of credit?" The short answer is yes, you do need to pay interest on the money you borrow. However, interest payments work a bit differently than they do with a credit card.

When you apply for a line of credit, you'll be given a credit limit, which is the maximum amount of money you are able to spend at any given time. Your line of credit, like a credit card or a loan, carries an interest rate. If you do not use your line of credit, you are not required to repay any money or pay interest.

Interest is only charged when you take money from your credit line until you pay it back and is only charged on the amount you borrow rather than the entire credit limit.

How is interest on a line of credit calculated?

So, how is interest on a line of credit calculated? Borrowers will often calculate interest on lines of credit by dividing the annual rate by 365 to obtain your daily rate. They'll then apply this rate to your daily account balance. At the end of the billing cycle, they will total the daily interest costs, which is the amount you will pay on top of the money you borrowed.

Ultimately, the more you borrow, and the longer you borrow it for, the more interest you will pay.

What is a student line of credit?

As mentioned, there are several types of credit lines available for Canadians to apply for. So, what is a student line of credit? A student line of credit is a type of loan line specifically designed for Canadians who want to pursue higher education.

But, unlike personal loans, students have the ability to borrow money, pay it back, and borrow it again as they need (as long as it remains within their credit limit). Rather than having a lump sum deposited into your account, a student line of credit ultimately offers students more flexibility when it comes to their spending.

With this type of credit line, students can pay for their tuition, textbooks, housing costs, and other daily expenses they may need to purchase during their semesters. A bonus to these types of credit lines is that most financial institutions offer students a grace period after they graduate, allowing them to pay back the remaining loan amount in more time.

Does a line of credit require collateral?

If you've never taken out a personal line of credit before, you may be wondering, "Does a line of credit require collateral?" The short answer is yes and no. It really depends on the type of line of credit you apply for. For example, a home equity line of credit does require applicants to put forth collateral, which is a high-value asset that can be seized if you are unable to pay back your loan within your repayment terms. In this case, the collateral would be your home.

Other lines of credit, like a student line of credit or even a personal line of credit, don't typically have collateral attached to them. That said, if you're applying for a higher credit limit with your line of credit, you may be asked to put collateral down, just in case.

What is a cash advance line of credit?

If you've heard of a cash advance, you may be wondering, "What is a cash advance line of credit?" A cash advance line of credit is a type of credit line offered by financial institutions that allows customers to access their funds as they need. Think of it kind of like a cash advance you'd receive with a credit card.

With a cash advance line of credit, you can request a cash advance from your line before the funds are deposited into your checking account.

Can you have multiple lines of credit?

So, can you have multiple lines of credit? The short answer is yes. You can have more than one line of credit, similar to having more than one credit card. However, whether or not this is a good option will depend on several factors, like your level of income, your personal spending habits, whether you're able to make your payments on time, and your overall credit history.

Before opting for more than one line of credit, consider whether applying for a higher credit limit is a better option. You may also want to consider a personal loan or other financial products. Don't forget to weigh the pros and cons, look at interest rates, and look over your finances before making a decision.

What are the problems with lines of credit?

While lines of credit offer flexibility and lower interest rates, there are potential downsides to consider. Some individuals may be tempted to treat the credit line as "free money" and end up accumulating substantial debt. Additionally, lines of credit may have higher fees than credit cards, such as annual fees or transaction fees, which can impact the overall cost of borrowing.

Is a line of credit worth it?

If you're considering a personal loan vs. a line of credit or credit card, the best thing you can do is compare the advantages and disadvantages of each borrowing method before choosing one that fits your needs. For now, take a closer look at some of the benefits and drawbacks of lines of credit below:

Advantages of credit lines

• Lower interest rates compared to credit cards.

• Flexibility to borrow as needed.

• Pay interest only on the money you borrow rather than your available credit.

• Potential tax benefits for certain uses (e.g., home renovations, tuition, and more).

Drawbacks of credit lines

• May require you to put down collateral.

• May have higher fees than credit cards.

• Potential temptation to overspend.

• May be charged an annual maintenance fee.

• You aren't able to earn rewards.

• Can lead to debt if not managed responsibly.

How do you use a line of credit?

To use a line of credit, you need to apply and get approved for one. Once approved, you can access funds through checks, online transfers, or by using a linked debit card. Repayments are typically made during a monthly billing cycle, and you have the option to pay the minimum amount due or more if you wish to reduce the balance faster.

What is a credit card?

A credit card is a payment card that allows you to borrow money from a financial institution up to a predetermined credit limit. It provides a convenient way to make everyday purchases, both in-person and online, without having to carry cash.

Credit cards come with various features and benefits, including rewards points programs, cashback offers, and insurance coverage.

Credit pros

• Convenient way to spend money.

• Wide acceptance both online and in-person.

• The opportunity to earn rewards.

• Helps build credit history.

• Purchase protection against suspicious purchases.

• Grace period for interest-free borrowing (if the entire balance is paid in full).

Credit card drawbacks

• Potentially high interest rates.

• The temptation to overspend.

• Fees for certain transactions (e.g., when you get a cash advance).

• Potential negative impact on credit score when personal finance is mismanaged.

How do you use a credit card?

Using a credit card is simple. Once you receive your credit card, you can activate it and start making purchases up to your credit limit. You must make at least the minimum payment by the due date specified on your monthly statement. Paying the full balance on time helps you avoid interest charges.

Instead of a line of credit can I increase my credit limit?

Yes, rather than applying for a line of credit through a financial institution, you should be able to increase the credit limit with your credit card issuer. If you decide to go this route, remember to use your credit responsibly, as credit cards tend to have higher interest rates.

You can request a higher credit limit through your banking app or reach out to your credit card company directly. Note that if your account is not in good standing with your credit card company, you may have a more difficult time increasing your credit limit.

What happens if I don't make the minimum monthly payment on my credit card?

Using credit cards responsibly can have a positive impact on your credit score. Making timely payments, keeping your credit utilization ratio low, and maintaining a long credit history can improve your creditworthiness by giving you a good credit score.

That being said, sometimes your plans for spending and saving can go south, especially when unexpected expenses come out of nowhere. When this happens, you may carry a high outstanding balance, miss payments, or frequently open new credit cards to spend more.

This is when things can get bad. Not only can it push you into having more credit card debt, but your non-payments will be sent to credit bureaus, which will lower your credit score and reflect poorly on your overall credit history.

Is it better to carry a balance on a credit card or line of credit?

Generally speaking, it's better to carry a balance on a line of credit than a credit card for a couple of reasons. The first is because a line of credit will often have lower interest rates than what's offered with a credit card, which will help you save money on interest over time.

Regardless of whether you choose a line of credit vs a credit card to borrow money, you'll need to make your minimum monthly payment each billing cycle to ensure you don't dig yourself into a debt cycle that's even more difficult to get out of.

Bottom Line

Both lines of credit and credit cards can be valuable financial tools when used responsibly. Understanding the costs, convenience, and rewards programs associated with each product is crucial. To use credit products responsibly, avoid cash advances (as they often have high interest rates and immediate interest charges) and carefully review the terms and conditions.

If you want to build your credit with KOHO, take advantage of our free credit score check before opening a virtual credit card with overdraft protection coverage to streamline your online purchases while having peace of mind.

KOHO also has several other financial products for Canadians like our high-interest savings, which can help you make a return on the money you choose to put away for a rainy day!

Note: KOHO product information and/or features may have been updated since this blog post was published. Please refer to our KOHO Plans page for our most up-to-date account information!