What Is A Personal Line Of Credit?

A personal line of credit can help you cover unexpected expenses, fund major projects or fill temporary cash flow gaps. It’s a form of revolving credit that gives you access to a pool of funds you can borrow from whenever you need cash.

Similar to a credit card, you can draw from a personal line of credit and repay the funds during what’s referred to as the draw period. When it ends, you’re no longer allowed to make withdrawals and will need to reapply to keep the personal line of credit open.

What is a personal line of credit (PLOC)?

A personal line of credit, or PLOC, is an unsecured revolving account with a variable interest rate. It’s a type of financing you can draw from as needed and pay back with interest, much like a credit card. It can be a viable option to help manage your daily cash flow, especially if you have an irregular income or are faced with an unexpected expense. If you have ongoing expenses, like medical bills or wedding planning, a PLOC’s revolving nature can offer flexibility

PLOCs generally have lower interest rates than credit cards, so they’re typically cheaper for big cash advances. However, because PLOCs are often unsecured, they’re best for consumers with a strong credit history. This means that a PLOC might not be the best option for everyone.

How does a personal line of credit work?

A personal line of credit operates much like a credit card in that you don’t borrow a specific amount like you would with a loan.

“You would go and apply for a line of credit in whatever amount you need, but you don’t walk out of the bank with a check,” said Adam Marlowe, chief strategy officer for Georgia’s United Credit Union. “You access the money as you need to use it, and your repayment is based on what you’ve used.”

Once approved for a PLOC, you can access funds via a revolving line of credit. That money can be tapped in various ways, including initiating a transfer via mobile app or withdrawing the funds at your local bank branch. Every draw will have to be repaid with interest, which is variable — meaning your interest rate will rise and fall based on market fluctuations.

It’s also important to note that most PLOCs have an expiration date.

“For instance, if you need a $3,000 line of credit, we’ll grant that line of credit and it’s good for two years,” said Marlowe. “You have an open revolving line of credit for $3,000 for two years.”

During the PLOC’s introductory draw period, commonly two to five years, you can keep borrowing from and repaying the line of credit up to its limit. But at the end of this term, you’d have to reapply with the lending institution to maintain the line of credit.

Repayment for personal lines of credit

Personal lines of credit are temporary. You’ll have a finite period during which you may withdraw funds, called a draw period. If you still have an unpaid balance when the draw period ends, you’ll enter the repayment period.

The structure of repayment can vary by lender. Common structures include:

• Draw and repayment periods: This is the most common type of repayment used for a PLOC, as described above. Typically, monthly payments are required during the repayment period.
• Balloon payments: This type of repayment requires that the full balance is due at the end of the draw period.
• Demand line of credit: While not very common, some lenders may set up a PLOC as a demand line of credit. This means the lender has the right to ask for full repayment at any time.

When setting up your personal line of credit, ensure you understand your lender’s repayment terms and make a plan that best suits your finances.

Personal lines of credit vs. personal loans

Like a personal line of credit, a personal loan is an unsecured debt product that lets you access the cash you need. Both require you to undergo a hard credit check to get approved, and the eligibility guidelines are generally the same. You can also expect to pay interest on the funds you borrow. But there are some key differences between a personal loan and a personal line of credit.

For starters, when you’re approved for a personal loan, you’ll receive the proceeds in a lump sum and repay the debt in monthly installments over a set period. So, you’ll be responsible for interest on the total loan amount.

Unlike the variable interest rate that comes with a PLOC, personal loan interest rates are fixed and often lower than you’d get with a personal line of credit since it’s less risky. So, you’ll get a predictable monthly payment that’s easier to work into your budget.

Pros and cons of personal lines of credit

A personal line of credit has several advantages over other fast capital sources, but it’s not the right choice for everyone. Consider both the benefits and drawbacks before applying.

Advantages of personal lines of credit

• Quick access to funds: With a personal line of credit, you can borrow money anytime during your draw period. You can access the line of credit through your bank branch, online or with a mobile app, depending on your lender.
• Overdraft protection on some accounts: If you’re worried about overdrafting an account, some banks will let you use a PLOC as overdraft protection. This can offer you security if you often write checks or worry about overdrafting your account.
• Competitive rates compared to credit cards: A personal line of credit typically has lower interest rates than a credit card. Your PLOC rate will depend on your lender and your personal credit history.
• No collateral required: While other options like home equity lines of credit use your home equity as collateral, a PLOC generally does not require any collateral. It can be a great option if you have good credit but don’t have a home or a car to use as collateral.
• Only pay for the draws that you make: With a PLOC, you don’t have to pay anything until you make a draw on your funds. You can withdraw funds of any amount within your limit, and you only pay for the amount you have withdrawn plus interest.

Risks associated with personal lines of credit

• Higher rates than HELOCs: A HELOC is considered a secured line of credit since your home is used as collateral. Secured forms of debt typically have lower interest rates due to the decreased risk to the lender. Since a PLOC is unsecured, you can expect higher rates.
• Interest isn’t tax-deductible: Unlike a HELOC, you cannot deduct the interest on a personal line of credit from your taxes.
• Hard to qualify with poor credit and/or limited credit history: Without any collateral backing a PLOC, the lender must take your word that you’ll repay your debt. Lenders rely on your credit history to understand your risk as a borrower, so you’re less likely to qualify for a PLOC if you have bad credit.
• Risk of overborrowing: You can borrow up to your limit on your PLOC throughout the draw period, but when the draw period ends, you must repay what you’ve used plus interest. If you don’t have a repayment plan, you risk overborrowing. Also, unlike credit cards, personal lines of credit don’t come with interest-free grace periods — expect to pay interest on any amount you borrow.
• Variable interest rates: Typically, a PLOC has a variable interest rate, which can make it challenging to budget for repayment since you can’t predict the total cost of borrowing.

Types of lines of credit

There are multiple types of lines of credit (LOCs). A personal line of credit is just one type — each type of LOC has its own set of pros and cons. Evaluating your borrowing needs and the characteristics of each type of LOC will help you determine which kind is best for you.

Personal lines of credit

If you have some unexpected personal expenses but no collateral (like a house or a car), a PLOC could be a good option. PLOCs are unsecured, so you’ll need good credit or better to qualify.

Business lines of credit

A business line of credit and a personal line of credit are functionally the same — you’ll receive a credit limit, from which you can draw from and pay back as needed. However, business lines of credit may have higher limits and are designed specifically for business purposes. A business may use a line of credit to buy equipment, manage short-term cash flow issues and more.

Home equity lines of credit (HELOCs)

A home equity line of credit uses the equity you’ve built up in your home to determine your borrowing amount. Unlike personal lines of credit, these loans are secured — meaning your home is used as collateral for the loan and failing to repay the loan could put your home at risk of foreclosure. However, because you take on more risk with this type of borrowing, interest rates are often much lower.

How to find the best personal line of credit

While they’re less common than personal loans, some financial institutions, including banks and credit unions, offer PLOCs. You’ll need two primary things to qualify for a PLOC: a good credit score and a solid credit history.

“You want to have the best credit you can have,” Dave Sullivan, credit expert with People Driven Credit Union, said. “If you have any revolving lines of credit, it’s best to pay those down as low as you can prior to applying, and make sure that info has been reported to the credit bureaus.”

Although a personal line of credit may have higher rates than other options like a home equity line of credit (HELOC), the interest rates on PLOCs are usually much lower than those of a credit card cash advance or payday loan.

Check with multiple lenders to see who will give you the best terms. You will want to consider interest rates, repayment terms and the length of the draw period.

The application process for a PLOC is much the same as applying for any loan, and it can often be completed online. Once you’ve decided on a lender and the credit limit you’re seeking, you’ll need to provide documentation to verify your identity and income.

Alternatives to a personal line of credit

You may find that a personal line of credit isn’t a good fit after exploring your options. If so, consider a personal loan or these alternatives to access the cash you need.

• Credit cards: Balance transfer credit cards come with an interest-free period, typically between 12 and 21 months. So, assuming you pay the balance in full before the promotional APR window ends, you can borrow money interest-free.
• Home equity loans: Home equity loans allow you to borrow against the equity you’ve built up in your home and receive a lump sum loan. You may be able to access a sizable amount of cash since most lenders let you borrow 75 to 85 percent of your home equity.
• 401(k) loan: If you have a 401(k) retirement plan with your employer, you may be able to borrow against the balance. There are no stringent income or credit score guidelines, making it an easily accessible option. However, if you leave your job or are fired before the loan is repaid, you may have to pay a penalty or repay the full balance immediately.

Bottom line

Like a credit card, a personal line of credit can be used on a revolving basis as needed. Borrowing money this way has many advantages, including providing quick access to cash and offering more competitive rates than credit cards.

But you’ll need a solid credit history to qualify and there’s a risk of overborrowing if you don’t have a history of using credit responsibly. Be sure to shop around and find the best interest rate and terms for your financial needs.

Frequently asked questions about personal lines of credit

• How do I qualify for a personal line of credit?
  

  Lenders generally assess your credit profile, income and debt load to determine whether you’re a good fit for a personal line of credit. Ideally, you’ll need good credit (or a FICO score above 670), a debt-to-income ratio below 36 percent and a stable income.

• What happens if I never use my line of credit?
  

  You only pay interest on the funds you pull from a personal line of credit. Still, you could be on the hook for administrative fees, even if you decide not to use the line while it is open.

• Does a personal line of credit affect my credit score?
  

  Applying for a personal line of credit requires a hard credit pull that will dip your score by a few points, but the impact is typically short-lived. As you borrow against the credit line, your score may fall since your credit utilization ratio will rise.

  However, if you repay the debt as agreed and keep the outstanding balance at or below 30 percent of the credit limit, your credit score can rise over time.

• Is it easier to get a loan or a line of credit?
  

  You can get a personal loan with less-than-perfect credit, but it may be a bit more challenging to qualify for a line of credit if your score is on the lower end. In fact, most lenders require good or excellent credit to qualify for a PLOC. A limited credit history can also be a deal-breaker.