What is the difference between 127.0.0.1 and localhost

Well, the most likely difference is that you still have to do an actual lookup of localhost somewhere.

If you use 127.0.0.1, then (intelligent) software will just turn that directly into an IP address and use it. Some implementations of gethostbyname will detect the dotted format (and presumably the equivalent IPv6 format) and not do a lookup at all.

Otherwise, the name has to be resolved. And there's no guarantee that your hosts file will actually be used for that resolution (first, or at all) so localhost may become a totally different IP address.

By that I mean that, on some systems, a local hosts file can be bypassed. The host.conf file controls this on Linux (and many other Unices).

Wikipedia sums this up well:

On modern computer systems, localhost as a hostname translates to an IPv4 address in the 127.0.0.0/8 (loopback) net block, usually 127.0.0.1, or ::1 in IPv6.

The only difference is that it would be looking up in the DNS for the system what localhost resolves to. This lookup is really, really quick. For instance, to get to stackoverflow.com you typed in that to the address bar (or used a bookmarklet that pointed here). Either way, you got here through a hostname. localhost provides a similar functionality.