Payday Loans vs a Line of Credit
Inside Subprime: Dec 17, 2018
By Jessica Easto
If you are looking for ways to manage expenses, you may have run across the term “line of credit.” What is a line of credit? And how is it different from, say, a payday loan? On its face, a line of credit may seem similar to other financial products, but it’s important to understand the differences.
A line of credit is a type of loan that both businesses and individuals can use to access money for a certain amount of time. When individuals do this, it’s called a “personal line of credit.” The lender, such as a bank, that issues the line of credit establishes a “credit limit,” which is the maximum amount of money you can borrow from them.
Personal lines of credit are usually used in specific situations where personal loans don’t quite make sense. They may be used when an individual knows they will need to spend money over a period of time, but they aren’t sure how much it will cost—such as with a restoration project, a wedding, or healthcare expenses. Lines of credit may also be used when month-to-month cash flow could be an issue, such as with an independent contractor whose income fluctuates significantly month to month.
Payday loans, on the other hand, give you the specified amount of money in one lump sum, while lines of credit let you borrow money as you need it over what is called a “draw period.” This can last for a long time, up to 10 years. You only have to pay interest on the money you borrow (as opposed to the full sum of your credit limit), and you can choose to paydown your debt as you go or wait for your repayment period to make minimum payments. (In this way, a line of credit is similar to a credit card.)
Payday loans, on the other hand, are marketed as a way to tide you over to your next paycheck. Because of this, the repayment terms are very short (usually no more than 14 days), and the loan amounts tend to be quite small (just a few hundred dollars). A line of credit can be extended for several thousands of dollars. It all depends on your credit score, which is another key difference.
In order to qualify for a personal line of credit, you need good credit—usually a score of 680 or higher. To get a payday loan, you don’t need any credit. Usually you just need a bank account. Payday loans are usually targeted at vulnerable populations who don’t have many options when it comes to managing their finances.
Payday loans are a form of predatory lending. And even though they are banned or regulated in many states, they are one of the most toxic types of loans available. They tend to use unfair or obscured loan terms, which often push borrowers further into debt. On the other hand, lines of credit are considered a safer way to borrow money.
One way to compare the two is to look at their annual percentage rates (APR), which accounts for the cost of interest and any other fees that borrowers will pay over the course of a year. Payday loans regularly have APRs around 400 percent. The APR of lines of credit fluctuate depending on your credit history and other factors.
When it comes to money management issues, one of the best things you can do it learn how to protect yourself from predatory lending and learn more about your options when it comes to expense management.