What are the Difference between Bad Credit Loans and Line of Credit

There are various loan options out there, but you oftentimes struggle to find a perfect deal for you. Each loan comes with different features and it is imperative that you are going to choose a deal as per your budget.

In case of bad credit history, you prefer taking out bad credit loans with an instant decision from direct lenders ignoring to the fact that some lenders approve applications for a line of credit for bad credit borrowers too.

What is a bad credit loan?

A bad credit loan acts like a personal loan; the only difference is the former charges higher interest rates because of high default risk. As you get money in your account, you can use it for any purpose. You will pay down a small amount of money along with interest every month unless the term expires.

The repayment period of bad credit loans may vary from three months to 36 months depending on the size of your loan as well as repayment capacity. It is very rare that the repayment length of the loan will be more than 12 months in case of impaired credit standing. If the loan is amortised, each payment will have both the principal and the interest.

What is a line of credit?

Loans allow you to borrow the full amount you need upfront. Contrary to loans, a line of credit lets you borrow up to a certain limit. You will repay the money along with the interest and then you can withdraw that money again.

For instance, your lender provides you with a line of credit up to £5,000. If you spend £1,000 in a month, that means you have left £4,000 to spend on other expenses. Once you repay the debt, you will be able to use £5,000 in full. Lines of credit charge fees each time you withdraw money. Credit cards act differently in that case. You will pay interest if you fail to pay off the debt within the grace period.

A bad credit loans vs. bad credit line of credit

Here is the difference between both types of funding sources:

Disbursal of funds

When you apply for a loan with a blemished credit file, the amount is disbursed in a lump sum after approval of your loan application. Loans with bad credit come with both instalment and lump sum features. You will have to borrow a large amount of money if you want to pay off the debt in instalments.

However, a line of credit will have a certain limit. You will withdraw money as per your requirement. In other words, you will borrow money as much as you need but up to the limit.

Interest rates

No matter which type of credit you apply for, you will end up paying high-interest rates if your credit report shows poor repayment history.

The interest rates for a loan with bad credit are generally fixed, and lines of credit charge variable interest rates. Bad credit loans are more likely to charge lower interest rates as compared to a bad credit line of credit.

Some direct lenders do not approve a line of credit in case of poor credit rating. This option is exclusively available for good credit borrowers because of expensive deals. Make sure that you have done enough research to know about lenders providing these deals to subprime borrowers.

Repayment

In case of bad credit loans, you have to pay down a fixed amount of money every month unless the term of the loan gets expired. The repayment amount depends on the method you opt for: equal total payment or equal principal payment plan.

A line of credit does not require you to pay off the entire balance. You will have to pay down the minimum balance to avoid penalty fees. It can be a fixed percentage of your debt depending on the policy of the lender.

Pros of a line of credit

A line of credit is a better option as you will borrow according to your requirements. If you take out a bad credit loan repaid in a lump sum, it will cause strain on your budget and the lender will not let you apply for a smaller amount in case of instalment payments.

A line of credit allows you to improve your credit score if you do not borrow the full amount available. This will keep your debt-utilisation ration as low as possible. Bad credit loans do not contribute to improvement in credit rating as long as you are to pay off the entire debt in a lump sum.

A line of credit has some benefits, but it comes with higher interest rates than bad credit loans regardless of repayment length. Further, if you continue to pay down the minimum balance, the interest will add up in the long run.

The bottom line

Both lines of credit and bad credit loans have their own pros and cons. Which option better boils down to your credit needs and financial circumstances.

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