Difference Between Loan and Line of Credit

David Cohn
July 20, 2021
Commercial loans

If you’re thinking about investing in commercial real estate and are looking for funding solutions, you may be wondering: Should you get a loan or a line of credit? What’s the difference between the two?

Loans and lines of credit are two different ways that individual investors or businesses can borrow funding from lenders.

A loan distributes the funds in a single, one-time lump sum. It’s essentially a non-revolving credit limit. The borrower can only access the loaned amount once, after which they need to make payments consisting of principal and interest until the entire debt is paid off.

Loan interest rates are generally lower than the line of credit interest rates, but closing costs tend to increase. Also, interest accrues on the entire loan amount right away.

Lines of credit work differently. They are similar to credit cards in that they give the borrower a predetermined credit limit. The borrower then makes regular payments consisting of both interest and principal to pay off a portion of the loaned amount.

You can use a line of credit for any purpose. The borrower can access the funds anytime, pay them back, and borrow them again. Because they are riskier than loans, credit lines usually have higher interest rates, but interest accrues when the money is accessed.

Now that you understand the basics of loans vs. lines of credit. Let’s discuss each type of funding in detail.

What are Loans?

Loans are based on the borrower’s creditworthiness and requirements. They come with specific dollar amounts and are granted as lump sums for one-time use, just like other non-revolving financing products.

There are Two Forms of Loans: Secured or Unsecured.

As its name suggests, a secured loan is backed by collateral—which in most cases is the asset for which the loan is taken out.

For example, a commercial real estate loan is secured by the commercial property. Should the borrower fail to fulfill their payment obligations and default on the loan, the lender has the right to repossess the commercial property, sell it, and apply the proceeds towards the remainder of the loan balance.

Depending on the loan agreement, the lender may be allowed to pursue the borrower for any outstanding amount.

  • Secured loans usually have lower interest rates because they’re not as risky as unsecured loans. Most borrowers are determined to hold on to the collateral, so they are likelier to keep up with the financial obligations of the loan. And even if they do default on the agreement, the lender can still get most (if not all) of their money back by selling off the collateral.
  • Unsecured loans are the opposite of secured loans. They are not backed by collateral in any form. Lenders rely solely on the credit history of the borrower when approving these types of loans. Because it is risky, this type of financing comes with higher interest rates.

Also Read: Frequently Asked Questions for Commercial Real Estate Investment

Types of Loans

Let’s talk about the most common loan types issued to borrowers:

1. Mortgages (commercial and residential)

Mortgages are specialized loan products for purchasing homes and commercial real estate. These loans are secured by the property in question.

Borrowers who want to qualify for a loan need to meet the lender’s income thresholds and minimum credit score requirements.

When the loan is approved, the lender essentially pays for the residential or commercial property and leaves the borrower to make regular payments (composed of principal and interest) until the entire loan amount is paid off.

Mortgages tend to have lower interest rates compared to other loans because properties back them.

2. Auto loans

Automobile loans work very much like mortgages. They are secured by collateral, which in this case is the automobile.

The lender essentially pays the vehicle seller the purchase price amount (minus any down payment the borrower may have made). The borrower then gets to use the car for as long as they adhere to the loan terms, including fulfilling regular payment obligations until the car loan is paid off.

Should the borrower default on the loan, the lender repossesses the car and may go after the borrower for the remaining balance.

3. Home or commercial real estate improvement loans

These loans are either secured or unsecured. Property owners who want to make repairs and renovations can approach banks and other lenders for funding.

4. Student loans

Also referred to as educational loans, this form of debt is specifically used to fund educational expenses and is offered through private and federal lending programs.

Lenders rely on the income and credit ratings of the parents of the student-borrowers, but the students become responsible for repayment later on.

Payments are deferred while the student-borrower is still in school, usually for the first six months or post-graduation.

5. Debt consolidation loans

Consumers who want to simplify their loan payments can choose to consolidate their debts into one. The bank essentially pays off all of the borrower’s outstanding debts and becomes the new lender.

Instead of making multiple payments—which can be confusing and often lead to missed payments or delays—the borrower will only be responsible for one payment to the new lender.  

6. Business loans

Also called commercial loans, this type of debt is a special credit product that small, medium and large businesses can use to buy more inventory, optimize day-to-day operations, hire staff, or build up capital for expansion.

What are lines of credit?

Similar to a credit card, a line of credit gives a borrower a pre-set credit limit that they can use any time for whatever purpose, pay back, and borrow again.

When a bank or lending institution approves you for a line of credit, they advance a revolving borrowing amount that you can use entirely or partially, over and over.

Lines of credit are much more flexible than loans in this sense. They can be used to make everyday purchases or to fund special requirements such as property renovations. You can also use them to pay down high-interest loans.

Lines of credit work very much like credit cards and even checking accounts, in some cases. The borrower can access their credit limit whenever they need to, for as long as their account is current and there’s still credit available for use.

So if the bank approves you for a line of credit with a $100,000 limit, you can choose to use all of it or just a portion of it for whatever you might need. If you carry a $75,000 balance, you still have $25,000 remaining to use any time. And if you pay off the $75,000, you can access the full amount of $100,000 again.

Some lines of credit work as checking accounts; you can make payments and purchases using a debit card that is linked to your credit line or write checks against your account.

Because they are riskier, credit lines have higher interest rates, smaller minimum payment amounts, and lower dollar amounts than loans.

Borrowers have to pay monthly payments consisting of both interest and principal. Interest-only starts to accumulate when you take out money against your credit line or make a purchase.  

It’s worth noting that a line of credit will create a more immediate and more noticeable impact on your credit score than a loan.

Types of credit lines

1. Business line of credit

Companies of all sizes use these lines of credit on an as-needed arrangement. When reviewing applications for business credit lines, the bank or lender considers the market value and profitability of the company, as well as their riskiness.

Business credit lines are either secured or unsecured, depending on how much money is requested. Interest rates are variable.  

2. Personal line of credit

This is an unsecured type of debt that is not backed by any collateral. Because this credit vehicle is considered risky for lenders, borrowers are required to have high credit scores to get approved.

Most banks are willing to issue personal credit lines indefinitely to borrowers with a good relationship with them.  

3. Home equity line of credit or commercial equity line of credit

More commonly referred to as HELOC or CELOC, this credit vehicle is secured by the market value of the borrower’s residential or commercial property. Banks and other HELOC/CELOC lenders consider how much the borrower owes on their mortgage.

Credit limits can go as high as 80% of the market value of the residence or commercial real estate asset, minus the amount still owed on the mortgage.

This line of credit comes with specific drawing periods (typically up to 10 years). The borrower is free to use, pay, and reuse their credit limit repeatedly during this time.

And because this is a secured line of credit, interest rates tend to be lower than personal credit lines.

Which one should you choose?

If you’re thinking of investing in commercial real estate, you probably wondering if you’re better off choosing a line of credit for a commercial real estate equity loan. It’s important to understand what options are available as you leverage your commercial property’s equity.

A commercial real estate equity loan distributes funds in a single lump sum. This type of loan is usually suitable for one-time, business-related expenses such as business expansions, purchasing vehicles, large equipment, additional property, and commercial property improvements.

Repayment is based on the interest rate and loan terms. There is a pre-agreed schedule and a set number of payments.

There are many benefits to taking out a commercial equity loan. First off, monthly payments are predictable, so they are easier to factor into your budget.

Funds are immediately disbursed in one lump sum. There’s also a wide variety of loan terms, including fixed and adjustable-rate options. Variable interest rates are adjusted annually.

But if you’re looking for flexibility and access to unlimited draws as necessary, a revolving credit option may be better for your situation.

It’s possible to get a commercial equity line of credit to use for property improvements, for purchasing commercial real estate, vehicles, or large equipment, as well as for business expansion.

Lines of credit offer many benefits, including convenient and instant access to funds. It can give you the money you need to take advantage of unexpected opportunities.

Most lenders don’t impose an annual fee for the first year. Also, interest is applied only on the portion of the credit line that is disbursed.

Commercial equity lines of credit can be a good option if you require a short-term CRE financing option. You can use the credit line multiple times, and instead of taking on monthly payments as you would in a CRE loan, you make payments until the balance is paid off.

This is why commercial equity lines of credit are widely used for financing inventory, receivables, and investments.

Finding a lender

Whether you’re looking for a loan or a line of credit to fund a commercial real estate project, it’s important to work with a full-service commercial property investment advisory firm.

CRE financial advisory firms can help you secure investment solutions such as:

  • Investment property loans
  • Bridge loans
  • Hard money loans
  • Construction loans
  • Stated income loans
  • Jumbo loans
  • Permanent loans

You can’t go wrong with a company that serves borrowers nationwide. The best ones offer customized CRE financing solutions that are usually not available from traditional lenders like banks. They have a network of lenders that look beyond credit scores and documented income, focusing instead on the commercial property value in question.  

For example, does your business make a lot of revenue, but you cannot provide proof of income for some reason or another? a CRE funding specialist can help you find stated income loans that don’t require as many documents.

Do you want to take advantage of a good deal but cannot afford to wait for the bank to approve a permanent mortgage? Bridge and jumbo bridge loans can provide you the money you need right away while waiting to get a long-term loan. Some of the best CRE investment advisory firms can help you get this type of financing on the same day.  

Suppose you need money for a commercial real estate transaction, but traditional lenders like banks have turned you down. In that case, a CRE financing advisor can recommend other solutions such as hard money and other types of loans.

You can expect faster closing (a matter of days instead of months), simpler application processes, and customizable loan terms and structures.

The best firms can also help you find financing for commercial property projects of all types and sizes—from multifamily apartments to industrial CRE. They can give you advice on quick and easy lending solutions depending on your objectives and goals. Their investment-specific approach is tailored to each borrower’s unique project characteristics.  

And because they are in the commercial real estate industry, they understand that year deal is unique and that your project comes with unique challenges and conditions.

They will evaluate your application from the point of view of a commercial real estate veteran, taking into account the specific circumstances surrounding the deal as well as your requirements and objectives. The result is a loan structure that is best suited for your commercial real estate project.

What’s more, the best CRE financial advisory firms don’t stop when they have lent to the money. Their team will follow up on the progress of your project and give you further assistance as necessary. They will be with you throughout the entire investment journey.

Waiting to secure funding via conventional banking can be an extremely frustrating experience, especially in the world of commercial real estate where most projects are time-sensitive.

By working with a CRE loan advisor, you can get quick access to a network of lenders that specialize in commercial properties and understand your needs as an investor.

A reliable team can deliver efficient communication, great customer service, and complete transparency. You don’t have to worry about hidden fees.

The application process is also extremely simple. Simply fill out the form (it should take less than 5 minutes) and wait for them to e-mail you a written disclosure of all loan terms within 24 hours.

If everything is acceptable to you, your loan will be funded in a matter of days, and you can start working on your CRE deal.

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