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What is the Difference Between a Car Loan and a Line of Credit?

The difference between a car loan and a line of credit lies mainly in the method of borrowing.

How a Car Loan Works

A car loan is always for a set amount with fixed repayment terms. You will make the same payment every month for the length of the loan, the interest rate will be fixed when you sign the contract, and you will know the exact date the car loan will be paid off. If you do not or cannot make your payments, the car will be repossessed by the lender, then sold at auction, and you will be liable for however much you still owe on the car post-auction. Repossession is bad for your credit, but the vehicle is the only asset that is actually at risk in this scenario.

How a Line of Credit Works

A line of credit is usually secured by a large value asset and has a variable interest rate. For the majority of people the asset is their home and the line of credit actually taps into the equity they have in their home. If you apply for a line of credit a lender will consider the value of the asset, your credit history, and ability to repay the line. After these items are considered, the lender will offer you a line of credit. Whatever amount the lender decides to extend to you will be placed in a special account that you will be able to write checks from. This account will expire after a set amount of time. Any money that you have used from that account will then need to be repaid on the same terms as a standard variable rate loan.

With a car loan the only asset you need to worry about, if you are unable to repay the loan, is the car you buy. With a line of credit you are placing your home at risk. Though some people do use a HELOC (Home Equity Line of Credit) to buy a car, it is often wisest to only use a line of credit to repair or remodel your home. You will still be paying off the HELOC long after the car has rolled its last mile with you at the wheel, and your interest rate could change substantially in the 15 years it takes to pay off the line of credit.