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 (PLOC) might be a better choice for your long-term financial health with its lower interest rates than credit cards and is sometimes tax deductible.
If you need access to cash and a flexible repayment plan, read on to learn more about personal credit lines. Below, we’ll tell you more about how they work, and the pros and cons of using them.
What is a personal line of credit?
A personal line of credit is a type of financing you can use to repeatedly withdraw (and repay) money up to a certain limit.
Personal lines of credit can come in handy when you’re working on a long-term project or preparing for unexpected expenses. If you do choose to get a personal line of credit, you can choose between a secured or unsecured one.
- Unsecured PLOC: Most personal lines of credit are unsecured. This means you don’t have to place any collateral to borrow money. But as a trade-off, you might have to accept lower credit limits and higher interest rates.
- Secured PLOC: You can usually get better interest rates and higher credit limits with a secured personal line of credit. This is because you have to place collateral which helps reduce some of the lender’s risk.
A personal line of credit can help you manage your finances, especially compared to other types of high-interest credit. Of course, you should understand the ins and outs of PLOCs and draft a repayment plan before you borrow to avoid getting into debt.
How does a personal line of credit work?
There are a few things you have to decide on your own before you can get a personal line of credit. For instance, do you want a secured or unsecured credit line? And do you want closed-end or open-end credit?
Once you decide, getting and using a personal line of credit goes something like this:
- 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 accrue 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: Most times, your credit line will remain available to you as you pay your debt. However, if you get a closed-end credit line, it will be like paying off a loan – when you spend and pay back the money, you can’t use it anymore.
Pros and cons of PLOC
A personal line of credit has several advantages over other sources of borrowed money, but that doesn’t mean it’s right for everyone. Consider the pros and cons when deciding whether to use a personal line of credit.
2 types of personal credit lines
There are two primary types of personal lines of credit: Home Equity Lines of Credit and overdraft protection.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (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 or a credit card linked to the HELOC, and they only pay interest on what they borrow.
- Maximum withdrawal amount: Usually, you can withdraw up to 85% of your mortgage balance but no more than 85% of your home’s value.¹
- Type of interest: Variable.²
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.
- Overdraft fees: Typically about $35 per transaction.³
- Type of interest: Flat fees or standard interest rates.4
How to apply for a personal credit line
The process of applying for a personal line of credit is similar to applying for a new credit card or personal loan. Depending on the lender, you might be able to apply online or in person. Regardless of how you apply, follow these steps to increase your approval odds.
1. Make sure you qualify for a personal line of credit
Look at your qualifications before you start applying for a personal line of credit. It’ll help you narrow your search and find lenders who might realistically offer you funds.
Here are some qualifications to consider:
- Good credit: You’ll generally need a FICO® Score in the good to excellent credit range to qualify for a personal line of credit.5
- 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 will 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
Sit down and figure out how much money you may need over time before choosing a PLOC lender.
This step can help you determine a credit line limit you’re comfortable with and whether you want an open-end or closed-end credit line. You should also determine how much you can afford to avoid overborrowing.
3. Compare lenders
Shop around and compare lenders to find a personal line of credit offer that fits your needs. Many lenders let you check your eligibility with a soft credit inquiry that won’t impact your credit score. Take advantage of this, and while you’re at it, talk to one of the lender’s representatives 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.
- Credit line duration: Ask if their personal lines of credit are open-ended or close-ended.
- 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. Keep in mind when applying, the lender will ask you to authorize a hard credit inquiry, which can take up to five points off your credit score.6
Alternatives to personal lines of credit
The decision to use a personal line of credit, a personal loan, or a credit card will depend on your current needs and financial goals. Read on to learn when it makes the most sense to use each type of personal credit.
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, the bank will give you the total amount upfront, and you have to repay it over a fixed amount of time. Personal loan interest rates are usually fixed and slightly lower than personal lines of credit, but you have less flexibility with repayment.
Personal line of credit vs. credit card
It’s smart to use credit cards for smaller or routine purchases like spackle and paint rollers, and personal lines of credit for larger expenses like countertops or labor costs.
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’re more convenient and have better rewards.
Is a personal line of credit right for you?
Personal lines of credit can be useful depending on your financial circumstances – especially if you anticipate needing revolving credit to cover ongoing expenses. However, avoiding more debt is always preferable.
If an emergency comes up and you are stuck waiting on your paycheck, consider other ways to make money fast before opening a personal line of credit.
Still have questions about getting or using a personal line of credit? Find answers below.
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 will 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, cash advance 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 have to make monthly payments until you’ve repaid the full amount, including interest. You can usually make payments online or by check or set up automatic withdrawals.
Where can I get a personal line of credit?
You can obtain a personal line of credit from financial institutions like 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 forms of financing. Or, start putting money into your savings account whenever you can.