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Key takeaways
- A personal line of credit (PLOC) is a flexible way to borrow money, pay it back, and then borrow again up to a limit.
- It works best for ongoing, variable costs like home repairs or smoothing out income gaps, rather than for one-time purchases.
- You only pay interest on the cash you actually use, not the full credit limit available to you.
- Interest rates on personal lines of credit are often variable, so your monthly payments could change.
When you need funds quickly, your first instinct may be to swipe your credit card – especially if you don’t have enough money in your savings. However, a personal line of credit, also known as a PLOC, might be a better choice for your long-term financial health since it may come with lower interest rates. Below, we’ll cover what a PLOC is, the different types available, how to use one wisely, and the pros and cons of borrowing money this way.
What is a personal line of credit?
A personal line of credit is a flexible loan that lets you borrow money, pay it back, and borrow again up to a pre-approved limit. Think of it like a credit card, but often with lower interest rates and higher borrowing limits.
Personal lines of credit can come in handy when you’re working on a long-term project or preparing for unexpected expenses. You can choose between a secured or unsecured personal line of credit depending on your needs.
This type of loan can help you manage your finances, especially compared to other types of high-interest credit. However, it is still a type of financing that comes with interest charges and possible fees.
You should understand the ins and outs of PLOCs and draft a repayment plan before you borrow to avoid getting into too much debt.
3 types of personal credit lines
Not all personal lines of credit work the same way. Here are three common types you’ll encounter.
Unsecured personal line of credit
An unsecured personal line of credit is a revolving credit account that lets you borrow money up to an approved limit. It doesn’t require collateral, so your approval, credit limit, and interest rate are based on your credit score and overall financial profile.
You’ll only pay interest on the amount you use and can withdraw money during your draw period, which may span several years. After the draw period ends, you’ll enter full repayment.
- Collateral requirement: None, approval and terms are largely based on your creditworthiness.
- Interest rate: Typically variable and may be higher than secured types of financing.
Home Equity Line of Credit (HELOC)
A home equity line of credit, or HELOC, is a type of revolving credit that allows homeowners to borrow against the equity in their property. The borrower can access the funds through checks, online withdrawals, or a credit card linked to the HELOC, and they only pay interest on what they borrow.
HELOCs often have a 10-year draw period, during which you can borrow funds, followed by a 10- to 20-year repayment period. HELOCs are secured lines of credit that use your home as collateral.
- Maximum withdrawal amount: Usually, you can withdraw up to 85% of your home’s value, minus what you still owe on your mortgage.
- Type of interest: Typically variable, though some lenders let you lock in a fixed rate during the draw period.
Overdraft line of credit
An overdraft line of credit is a financial arrangement that allows an account holder to overdraw their checking account up to a specified limit. It works as a personal line of credit by covering transactions when you experience temporary cash flow problems. With an overdraft line of credit, you can avoid overdraft fees, which can add up quickly.
- Overdraft fees: Typically about $35 per transaction.
- Type of interest: Flat fees or standard interest rates.
How does a personal line of credit work?
Before you can get a personal line of credit, you’ll need to make a few decisions. Do you want a secured line that requires collateral or an unsecured one? Will you need open-end credit that you can reuse or closed-end credit like a one-time loan?
Once you decide, here’s how it works:
- A lender approves or pre-approves you. A lender will review your income, credit score, and other relevant factors to determine your maximum borrowing limit.
- You use the money as needed. Once approved, you can use the money whenever you need it, only paying interest on the amount you use.
- You pay back the amount you borrowed and interest. Interest charges begin to grow when you use the borrowed money. You usually have to make a minimum payment for continued access to your line of credit.
Your personal credit line closes or recuperates: Your credit line can remain available to you as you pay your debt. This is different from closed-end credit, like a loan, where you borrow money and pay it back one time.
What can you use a personal line of credit for?
A personal line of credit can be a useful tool for expenses that might change or pop up unexpectedly because of its flexibility.
Emergency expenses
Life throws curveballs. A PLOC can cover unexpected costs like car repairs, medical bills, or urgent home fixes when your savings falls short.
Home improvement projects
Renovations rarely go to plan, and costs can jump. A line of credit lets you pay for materials and labor as you go without borrowing a lump sum upfront.
Managing cash flow gaps
If your income fluctuates as a freelancer or commission worker, a PLOC can bridge the gap between paychecks. Borrow what you need and pay it back when money comes in.
What you shouldn’t use a personal line of credit for
Avoid using a PLOC for vacations, luxury items, or everyday purchases. Variable interest rates mean these non-essential buys could cost you significantly more over time.
Pros and cons of a personal line of credit
Personal lines of credit have clear advantages, but they’re not right for everyone. Here’s what to weigh before you apply.
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Personal line of credit vs. other borrowing options
The decision to use a personal line of credit, a personal loan, or a credit card depends on your current needs and financial goals. Here’s when each option makes the most sense.
Personal line of credit vs. personal loan
Personal loans are best for fixed expenses like a roof replacement. A personal line of credit is usually better for ongoing expenses like a remodeling project.
When you take out a personal loan, a lender gives you the total amount upfront, and you repay it over a fixed amount of time. Personal loan interest rates are usually fixed, while personal lines of credit are typically variable. You generally have less flexibility with a loan than a line of credit because it’s disbursed as a lump sum.
Personal line of credit vs. credit card
Personal lines of credit and credit cards are similar in that you have a credit limit, monthly bills, and minimum payments. The difference is in how you’re supposed to use them.
Credit cards are for routine and low-cost expenses like groceries, supplies, and subscriptions. They tend to have higher interest rates than personal lines of credit, but they are more convenient and may offer rewards.
Personal lines of credit are typically better for larger expenses, such as countertops and labor costs if you’re renovating your kitchen.
How to apply for a personal credit line
The process of applying for a personal line of credit is similar to applying for a credit card or personal loan. Follow these steps to boost your approval odds.
1. Make sure you qualify for a personal line of credit
Check your qualifications before applying to narrow your search and find lenders who’ll realistically approve you. Here’s what lenders look for:
- Good credit: You’ll generally need a good credit score to qualify for a personal line of credit.
- Checking account: Some financial institutions might also require you to have a checking account with them.
- Payment history: Your credit report should show a proven track record of on-time payments.
- Financial position: Lenders often check your debt-to-income ratio and may consider other assets, like savings and investments, that could affect your ability to pay back however much you borrow.
2. Figure out how much money you need
Calculate how much you’ll need over time before choosing a lender. This helps you pick a comfortable credit limit and avoid borrowing more than you can afford.
3. Compare lenders
Shop around and compare lenders to find the best offer. Most lenders let you check eligibility with a soft inquiry that won’t hurt your credit score. When comparing, ask about:
- Interest rates: Determine if they have a fixed or variable interest rate. Also, ask what the average interest rate is.
- Fees and charges: Find out if they have hidden charges like annual fees or early repayment penalties.
- Type of credit line: Find out if you have to place collateral to get a personal credit line and what forms of collateral they accept.
4. Submit an application
Before you sit down and apply for a personal line of credit, ensure you have all the information and documentation you need. Here’s a list to start with:
- Proof of identity like a driver’s license, passport, or Social Security card.
- Proof of income like pay stubs, W-2s, or tax returns.
- Proof of residence like a lease agreement or mortgage statement.
- Financial statements like investment or bank statements.
Once you’ve followed the steps above, you’ll then fill out and submit an application. When you apply, the lender typically asks you to authorize a hard credit inquiry, which can take up to five points off your credit score.
Is a personal line of credit right for you?
Personal lines of credit work well for ongoing expenses, especially if you need revolving credit. They may be a good fit if you’re financing a large expense, such as home renovations, and have a solid plan for repayment. That said, avoiding debt whenever possible is usually your best move.
Frequently asked questions about personal lines of credit
Is it a good idea to get a personal line of credit?
Getting a personal line of credit can be a smart move if you need flexible cash access for ongoing projects or fluctuating income, and it typically beats high-interest credit cards for larger expenses. However, if you tend to overspend, open-ended credit access could lead you into unnecessary debt.
How hard is it to get a line of credit?
It’s tougher to get a line of credit than a credit card – lenders typically want a good-to-excellent credit score, a solid payment history, and proof you can afford the payments.
What's the difference between secured and unsecured personal lines of credit?
A secured personal line of credit is backed by collateral, which can help you qualify for a lower rate. Unsecured personal lines of credit typically come with higher interest rates since it’s riskier for lenders to let you borrow that money without collateral.
Do personal lines of credit have hidden fees?
Personal lines of credit may have additional costs like annual fees or late payment penalties. To avoid these, carefully review the terms and conditions before borrowing money.
How do I repay a personal line of credit?
When you borrow money from a personal line of credit, you can typically withdraw funds during your draw period and pay them back during the repayment period on a monthly basis. You can pay more during the draw period if you want to cut down on interest charges. Note that some lenders require a balloon payment at the end of the draw period.
Where can I get a personal line of credit?
You can obtain a personal line of credit from various financial institutions, including banks, credit unions, and online lenders.
What are my options if I'd rather not take out a personal line of credit?
If you prefer to avoid taking out a personal line of credit, consider alternatives like personal loans, credit cards, or other ways to borrow money. Or, start putting money into your savings account whenever you can.