What is a personal line of credit and how does it work?

A personal line of credit allows you to borrow up to a certain amount for a given period of time whenever you need cash. If you need a flexible borrowing option, this may be your solution. Here’s a breakdown of what is a personal line of credit, its benefits, and your other alternatives.

Whether you need to finance unforeseen expenses or for other purposes, a personal line of credit may offer support. Insight into how this line of credit works can help you use it to your advantage and fund your needs. 

How does a personal line of credit work?

A personal line of credit (PLOC) is a flexible financing option that gives you access to funds on an as-needed basis. Meaning you don’t receive a lump sum when you take out a personal line of credit. Much like a credit card, a PLOC is a revolving line of credit that allows you to borrow money up to your credit limit. 

It varies per lender and situation, but typically, your credit limit can run from $500 up to $100,000. You then only need to pay interest on the amount you draw. Remember, a personal line of credit usually has a variable interest rate, so your rate fluctuates based on market conditions. 

Say you’re granted a $7,000 personal line of credit valid for 3 years. You have access to that amount up to your draw period, which is 3 years. During this time, you can make multiple draws and repayments as needed. But keep in mind that every dollar you draw accrues interest. 

Considering the example above, let’s say you withdraw $2,500 to renovate your house. When your monthly bill arrives, it’ll show that you owe $2,500 plus interest and any fees you incur. Depending on your lender and agreement, you may need to pay back the minimum monthly payments or interest-only payments. This can either be a flat fee or a percentage of your remaining balance. 

Personal loans vs personal lines of credit

Both personal lines of credit and personal loans allow you to fund different needs. However, understanding their differences can help you decide which is best for your situation.

With a personal loan, you receive a lump sum when you are approved. Then, you make monthly installment payments over your loan term. The interest is also charged based on your loan amount. 

On the flip side, a personal line of credit is a revolving account where you can draw funds as needed. You only pay interest on the amount you borrow each time. And unlike personal loans, a PLOC allows you to borrow multiple times as long as you replenish your credit limit. 

Pros and cons of a personal line of credit

Understanding the benefits and drawbacks of personal lines of credit can help you decide if this option works in your favor.

Pros	Cons
Constant access to credit Flexible use of funds Quick access to your credit Only pay interest on the amount you borrow Lower interest rates than credit cards No need for collateral	Fluctuating interest rates Additional costs, such as application fees and annual fees Stricter credit score and credit history requirements Risk of overspending Lack of grace periods

Pros of a personal line of credit

• Constant access to credit: You have ongoing access to your predetermined credit limit, allowing you to borrow funds whenever you need. And since a personal line of credit is a revolving credit, your available credit automatically renews as you pay off your balance. This gives you a safety net for unforeseen expenses or emergencies.
• Flexible use: Personal lines of credit can be used for a variety of purposes. That said, you can draw funds for medical emergencies, home renovations, vacations, and more.
• Quick access: You can conveniently access your available funds whenever you need them. For example, you can draw them through banks or credit unions and mobile apps.
• Only pay interest on the amount borrowed: With a personal line of credit, you only have to pay interest on the amount you withdraw. This means don’t need to pay interest on your entire credit limit, so you can control your borrowing costs. 
• Lower rates than credit cards: In general, personal lines of credit have lower interest rates compared to credit cards. But remember that your rate still depends on your lender and situation.
• No collateral needed: Most PLOCs are unsecured. Meaning you don’t need collateral to apply for credit, so this makes it an appealing option if you don’t own any assets. 

Cons of a personal line of credit

• Variable interest rates: Personal lines of credit often have variable interest rates. This means the interest you pay can increase or decrease over time. Other than that, a variable rate makes it harder to predict your balance. 
• Additional costs: While PLOCs are convenient, they may come with extra fees depending on the financial institution. These may include annual fees, application fees, or maintenance fees, which can add to your overall expenses.
• Stricter credit requirements: You typically need good or excellent credit to qualify because it’s an unsecured loan. If you have a poor or limited credit history, lenders may be reluctant to approve your application
• Risk of overspending: You may be tempted to overborrow since you have constant access to your credit. To avoid issues ahead, ensure you only borrow what you need and carefully manage your funds.
• No grace periods: Unlike some credit cards, personal lines of credit usually don’t have grace periods. So, you begin accruing interest every time you make a withdrawal.

How hard is it to get a personal line of credit?

Obtaining a personal line of credit can either be easy or challenging depending on your circumstance. Since a PLOC is commonly unsecured, you need to convince lenders of your creditworthiness.

You’re more likely to be approved for a personal line of credit if your lender sees you as a low-risk borrower. For instance, showing a positive payment history and a high credit score indicates you’re a responsible borrower. Usually, using the FICO scoring model, a good credit score ranges from 670 and higher. 

It may also increase your chances if you have a stable income and employment. These suggest you can afford to pay the funds you draw.

On the other hand, it may be hard to get a personal line of credit if you have a poor credit score or a limited credit history. In this case, some lenders may offer a secured line of credit. Meaning you need collateral, like your savings account or property. So, before applying, make sure your financial profile fits the lenders’ criteria. 

Do you have to pay back a personal line of credit?

Usually, you get a monthly bill with your cash advances, payments, interest, and other fees. But depending on your lender and agreement, you may have draw and repayment periods or balloon payments. 

Draw and repayment periods

Personal lines of credit commonly have draw and repayment periods. During the draw period, you can access funds from your line of credit as needed. This means you’re free to borrow and repay multiple times within this period. So, like a credit card, your repaid funds go back to your available credit. 

Once your draw period ends, the repayment period starts. At this stage, you are typically required to make monthly payments toward any outstanding balance left. Keep in mind that you cannot draw your funds anymore during the repayment period. 

Balloon payments

In some cases, you may also be required to pay the full balance at the end of your draw period. This is called a balloon payment. Unlike the draw and repayment periods, balloon payments involve paying off your outstanding balance in a lump sum. 

Where to get a personal line of credit? 

Though a personal line of credit is usually available in a bank or credit union, some online lenders also offer this option. 

• Banks: Several banks offer personal lines of credit. In some of them, you’re required to have a checking account or money market account with the same bank before you open a PLOC.
• Credit unions: Credit unions offer a range of financial services. More often than not, you have to be a member to apply for a personal line of credit from a credit union. 
• Online lenders: Online lenders sometimes provide personal lines of credit. Beyond convenience, they also often have flexible lending requirements compared to banks. 

You can apply for personal lines of credit from many financial institutions. So, research and compare multiple lenders before deciding. Pay attention to the interest rates, maximum credit limits, potential fees, and overall terms and conditions. With this, you can find the one that aligns with your situation. 

Types of lines of credit

Aside from personal lines of credit, there are other lines of credit that you may come across. 

Home equity line of credit

Home equity lines of credit (HELOCs) are for homeowners who have enough equity in their properties. With this line of credit, you may access a percentage of your home equity. Equity refers to the difference between your home’s current value and the amount you still owe on your mortgage. 

Depending on your lender, you may borrow up to 85% of your equity or even more. Somewhat like a personal line of credit, a HELOC also has draw and repayment periods. But compared to a PLOC, interest rates are often lower in a HELOC.

A HELOC is a secured loan, so you use the equity in your home as collateral for your credit line. Meaning your lender can seize your home if you fail to repay. So, ensure you only borrow what you need to avoid risking your collateral. 

Business line of credit

Like a PLOC, a business line of credit provides access to funds up to your predetermined limit. But with business lines of credit, you may potentially have a higher limit since it’s specifically for business purposes. You can typically use a business line of credit to finance business expenses or capital, like inventory and payroll. 

This line of credit can be secured or unsecured. In secured debt, small businesses need to put up collateral, such as equipment or property. Meanwhile, unsecured debt doesn’t require assets. Although in other cases, lenders may still ask for a lien on your business assets or a personal guarantee.

Alternatives to personal lines of credit

If a personal line of credit is not for you, there are some alternatives you can look out for.

Personal loans

As mentioned before, you get a lump sum with a personal loan. Interest is charged on your loan amount, and you make monthly payments over your loan term. And unlike a PLOC, you need to re-apply for a personal loan if you’ve used up the funds but need more cash. 

That said, a personal loan is best for a one-time expense especially if you know how much you need. Like a personal line of credit, a personal loan is usually unsecured and doesn’t require collateral. So, you also need to meet lenders’ credit requirements. Still, some lenders offer secured personal loans. 

Credit cards

Even if credit cards have higher interest rates than PLOCs, they often have grace periods where you don’t acquire interest charges. This may be 21 to 25 days depending on your credit card provider. Throughout the grace period, you can pay your credit card balance without any interest. 

Besides a grace period, some credit cards also have perks, like rewards, cashback offers, and travel points. With that in mind, a credit card is commonly best for ongoing small to medium expenses. 

Payday and pawn loans

Payday loans are frequently short-term loans with very high rates. Then, pawnshop loans require you to use your personal belongings, like jewelry, as collateral.

A payday or pawn loan often has outrageous interest rates. Although both provide quick cash, their predatory rates often trap consumers in debt. So, explore your options before considering these loans.

In summary

Personal lines of credit offer flexible access to your funds as needed, but it also has its drawbacks. To benefit from a personal line of credit, it’s crucial to understand how it works and how it compares to other options. Through this, you can efficiently manage your credit and confidently finance planned or unexpected expenses.

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