Are money woes getting the best of you? Maybe the bills are piling up due to an unforeseen financial emergency that’s left you broke, or your paychecks always seem to be a dollar short or a day late.
If so, a personal line of credit (PLOC) could be just what you need to get over the hump, or at least that’s what you may have heard.
How does a personal line of credit work?
Similar to a credit card, it’s a way to borrow money, usually from a bank or credit union, that can be used when you’re strapped for cash. In other words, all the funds are not distributed in one lump sum like a personal loan.
Instead, you only withdraw what you need, typically by initiating a transfer into your account. You only pay interest on the outstanding amount you use.
So, if you’re approved for an unsecured personal line of credit with a $1,500 credit limit and need to borrow $500 to replace your tires, you’ll transfer this amount to your checking account and withdraw the cash. At this point, your outstanding balance will be $500 plus any interest accrued if you don’t pay the balance in full before the due date.
Unsecured vs. Secured Lines of Credit
Personal lines of credit are unsecured, which means they’re not tied to any form of collateral. This means your assets will be safe even if you default on the loan (but your credit score will take a hit).
On the other hand, secured lines, like a home equity line of credit (HELOC), require that you attach some form of collateral to the loan, notes the Consumer Financial Protection Bureau. In this case, your home could be foreclosed if you fail to make timely payments.
You’ll need to have good to excellent credit to qualify for an unsecured line of credit. Otherwise, you may be stuck with a secured option that requires a cash deposit (typically held in a savings account or CD) or a HELOC.
Benefits of a Personal Line of Credit
Competitive Interest Rates
When was the last time you checked out interest rates on credit cards? It may be tempting to swipe your plastic when you’re in a financial bind, but the interest alone could keep you in debt for several years to come.
By contrast, personal lines of credit are sometimes accompanied by substantially lower rates that will save you a bundle in interest. You may also find that the rates on a personal line of credit are lower than what you’d find with traditional fixed-rate personal loans.
Helps Build Positive Payment History
As long as you make timely payments each month to the lender, your credit score could benefit as payment history accounts for 35%. But be sure to keep the balance loan, or your credit utilization ratio could skyrocket, which means trouble for your credit. More on that shortly.
Another added benefit is it lowers your credit utilization ratio if you refrain from drawing funds from the credit line. In other words, it’s beneficial to have unused credit sitting on your report.
Quick and Easy Way to Access Cash
You don’t have to wait seven days for a new credit card to arrive in the mail or resort to begging relatives and friends for money when you need it most. Instead, the personal line of credit will be available when you need it, and it only takes a few seconds to transfer the funds to your checking account and have access to the cash you need.
Ideal for Income Smoothing
If you’re self-employed, it’s not uncommon for vendors to make payments on their own timetable. No matter how many late payment stamps you embed on invoices or penalties you impose to repeat offenders, there will also be a few clients that miss payment cutoffs, which can send your finances into a frenzy.
Having cash reserves can be useful for smoothing out your income. However, if you’re just starting out or experiencing financial difficulties, a personal line of credit can help you pay bills and meet other expenses until you receive regular income.
Drawbacks of a Personal Line of Credit
Not Ideal for No Credit and Poor Credit Borrowers
Having less than perfect credit doesn’t necessarily disqualify you from getting approved. However, the unsecured personal lines of credit with the most competitive interest rates go to borrowers with good or excellent credit.
Lenders will also consider your income to determine how much of a loan you can afford. For example, if your income has been a bit unstable or low recently, you may not qualify for a line of credit.
It Could Be Damaging to Your Credit History
As mentioned earlier, you want to keep your credit utilization ratio to a minimum. This is the amount borrowed against the total credit limit. So, $500 borrowed from the $1,500 line of credit would yield a 33% credit utilization ratio. Word to the wise: lenders like to see this amount at 30% or lower.
But the higher your credit utilization ratio, the more of a hit your credit score takes, as 30% of your FICO score is calculated by the aggregate amount owed on revolving debt.
Limited Loan Term
Unlike credit cards, personal lines of credit are only open for a set period, usually ranging between three and five years. This is commonly referred to as the draw period.
When it ends, the personal line of credit will close, and the repayment period begins. You’ll have to remit at least the minimum monthly payments over a set time frame (specified by the lender) until the balance is paid in full.
Where to Get a Personal Line of Credit
There are several places where you can get a personal line of credit, including banks, credit unions, and online lenders. Here are some of the major banks and credit unions that offer personal lines of credit:
- Citibank: $1,500 – $25,000
- Delta Community Credit Union: Up to $20,000
- First Services Credit Union: $1,000 – $30,000
- KeyBank: $2,000 – $25,000
- PenFed Credit Union: Up to $25,000
- PNC Bank: $1,000 – $25,000
- Regions Bank: $3,000 – $50,000
- TD Bank: $20,000 – $50,000
- Truist: $5,000 – $50,000
- Upgrade: $500 – $25,000
- U.S. Bank: Up to $25,000
- Wells Fargo: $3,000 – $100,000
Should you apply for a personal line of credit?
It depends on your financial situation. Start by asking yourself if it’s the most inexpensive form of credit you could retrieve to find the relief you need.
If a credit card is your only other option, the answer will probably be a yes assuming the interest rate is substantially higher than what you’d qualify for with a line of credit. Otherwise, it may be best to explore other options, like balance transfer credit cards.
Another major factor to consider is how a personal line of credit could impact your credit utilization. Personal lines are reported as revolving credit and not installment loans (which have little to no impact on your credit utilization ratio.) So taking out a line of credit only to max it out could do temporary damage to your credit until the personal line of credit is paid off.
But if you’re simply looking for a way to smooth over your income or get over a temporary rough financial patch, a personal line of credit may not be such a bad idea. It beats incurring excessive overdraft and disconnect fees, or even worse, blemished credit due to delinquent payments on other debts.
If you decide to take out a personal line of credit, use it as a short-term solution to remedy cash flow issues. In the meantime, work on increasing your safety net so you’ll be covered when you encounter financial hurdles. Furthermore, work on improving your credit score so you can qualify for more competitive loan products later on down the line if the need arises.