Know the difference between a loan and a credit facility

Choosing the correct product according to your needs is critical to making smart financial decisions. Credit options can be separated into two main categories - loans and credit facilities. But for some people, the lines can be blurred between the two.

We asked Cowyk Fox, managing executive of Transactional Banking at Absa, about the differences between the two.

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What is a loan? 

Fox points out that loans are generally fixed amounts that are required for a specific purchase. They can be associated with an asset, but they don’t necessarily have to be.

Buying a vehicle or a house would mean that the asset is still in the possession of the bank until the loan is repaid, but for a personal loan this is not the case - you have full discretion to use the money as you see fit.

All fixed-term loans are set up for a specified period and repayment amount, unless the interest rate changes. This helps to simplify financial planning and budgeting.

Loan terms can range from three months to 30 years, depending on the type. Home loans usually have the longest term, followed by vehicle finance.

The total interest paid will depend on the amount you’ve borrowed. Whether you use the money or not, you will still pay the interest.

With unsecured loans, such as personal loans, the interest rate may be higher. This is because creditors have no way of recovering their funds if you default on your payments for any reason. 

Another significant thing to note about loans is that once you pay back the owed amount, you’ll have to apply again to get a new amount. The same application process will take place - you will have to submit the relevant documents, affordability will be assessed, and your creditworthiness checked.

Loans are generally larger than credit facilities.

What is a credit facility?

A consumer report issued by the National Credit Regulator indicates that credit facilities are very popular with South African consumers.

Credit facilities offer credit to a set limit, and this is available for you to utilise at any point in time, says Fox. Credit cards, garage cards, store cards, and overdrafts fall within this category.

When it comes to credit facilities, everything you repay is available to use again, and interest is only calculated on the balance that you have used.

Credit facilities are usually combined with a payment mechanism, such as a card, which offers a compelling alternative to cash.

One of the main benefits of using a credit facility is the availability of credit at all times. This is particularly handy in emergencies.

Credit cards offer additional benefits, Fox points out. These typically include interest-free periods of 55 days, reward programmes, airport lounge access, and basic travel insurance.

Credit facilities do, however, tend to have higher interest rates when interest-free periods expire.

Which is the better credit option?

The best credit option for you will depend on how you plan to use the credit. A loan is appropriate for a specific requirement such as a home or vehicle. It allows you to budget and settle the debt within a predetermined period of time.

Credit facilities, on the other hand, are ideal for day-to-day use, offering flexibility and backup credit at any time. Additional benefits are available with optimal use of the interest-free periods and rewards.

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