You will be able to explain when a credit line is cheaper or dearer than an instalment loan.
While Aisha was reading her loan offer, her bank's app showed a second option underneath: a credit line, with a limit already approved and no fixed repayment schedule. Draw what you need, it said, and pay interest only on what you use. It sounded more flexible than the loan, and in some situations it is. In others it is one of the more expensive ways to borrow you can sign up for.
The difference comes down to how long you need the money and whether you will actually pay it back on time.
A credit line is an approved limit you can borrow against whenever you like, usually by transferring money to your bank account or by drawing on a linked account. You pay interest only on the amount you have drawn, for the days you have drawn it. Repay some or all of it and that part of the limit is free to use again.
There is a minimum monthly payment, as with a credit card, but no fixed term and no date by which the balance must be gone. Interest is usually calculated daily on the outstanding balance and charged monthly.
Compared with an instalment loan, the interest rate on a credit line is usually higher, often closer to card rates than to personal loan rates. Many credit lines also carry an annual fee, which you pay whether you draw on the line or not. Both figures are in the product's terms, along with any fee for each drawdown. Read them before you open one.
Interest on what you use, for the days you use it, is a real advantage when the need is short or uncertain.
Say Aisha's siblings promise to repay her within about two months. She draws S$3,000 for a smaller part of the dental bill and clears it in two months. At an example rate of 20% a year, the interest is roughly S$3,000 times 20% divided by 12, times 2, which is about S$100.
Now compare a one-year instalment loan for the same S$3,000 at an example flat rate of 3.5%. The flat interest is S$105 for the year, charged in full across the instalments. If she repays early after two months, she may face an early repayment charge, and she may not get back all of the unearned interest, depending on the terms. The headline rate on the instalment loan is far lower, but for a two-month need she pays for twelve months of a loan she does not want.
Credit lines also suit needs where you don't know the amount in advance, such as a renovation with uncertain final costs or a gap between a payout you are owed and a bill that has to be paid now. You draw what you need when you need it.
The same features become expensive when the money stays borrowed. If the siblings take a year rather than two months, Aisha's credit line is now a long-term loan at a short-term rate.
Using the same example figures, S$3,000 repaid in twelve equal monthly payments at 20% costs about S$335 in interest. The one-year instalment loan at 3.5% flat costs S$105, an EIR of about 6.4%. Over a full year, the credit line costs more than three times as much in interest.
And that assumes she repays steadily. If she pays only the minimum each month, or nothing beyond the interest, the S$3,000 can sit on the line indefinitely, costing about S$600 a year at the example rate and never getting smaller. There is no end date to force the balance down. People who open a credit line for a short need and then find it still drawn three years later are not unusual.
Because the lender does not set a repayment schedule, you have to set one yourself. The simplest way is to decide, before you draw, the date by which the balance will be zero and the monthly amount that gets you there. Then treat that amount like an instalment, by standing instruction from your bank account if you can.
If you cannot name a realistic end date, that is a sign the need is not short at all. A long or open-ended need usually belongs on a product with a fixed term and a lower rate, which is the instalment loan from lesson 3.1, Personal instalment loans: fixed payments on a flat rate.
The same thinking applies to any revolving credit, including the credit card in module 2. A limit you can draw on again and again is only cheap when it is cleared quickly.
Most of the choice between a credit line and an instalment loan comes down to one question: how sure are you about when the money comes back? Short and certain favours the credit line. Long, or uncertain in a way that might stretch out, favours the loan.
Think of something in your own life that might need a lump sum: a course fee before your employer reimburses it, a medical bill, a gap between jobs. Picture one version where a credit line would come out cheaper and one where it would cost more, and the difference between them will usually be time.
Write down a situation where a credit line would be cheaper than an instalment loan, and one where it would cost more.
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