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.
Key Takeaways
- A personal line of credit (PLOC) is a flexible loan option that allows you to borrow money as needed, similar to a credit card, and pay interest only on the amount used.
- Benefits include competitive interest rates, building a positive payment history, quick access to funds, and helping to manage cash flow for those with irregular income. Drawbacks include potential damage to your credit score if not managed well, higher interest rates for those with poor credit, and limited loan terms.
- To secure a PLOC, you need good to excellent credit for the best rates, and you can obtain one from various banks, credit unions, or online lenders, with limits typically ranging from $500 to $100,000.
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 of credit, like home equity line of credits (HELOCs), require that you attach some form of collateral to the loan. In the case of HELOCs, the loan is backed by a mortgage on your home. This means your home could be at risk of foreclosure if you fail to make timely payments. According to the Consumer Financial Protection Bureau, HELOCs can offer lower interest rates compared to unsecured lines of credit because they are less risky for lenders.
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 home equity line of credit.
Benefits of a Personal Line of Credit
A personal line of credit offers several advantages that can make it an attractive financial tool for many individuals. Whether you need funds for an emergency, a significant purchase, or to smooth out irregular income, a personal line of credit can provide the flexibility and convenience you need. Here are some of the key benefits:
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
While a personal line of credit has many benefits, it’s important to consider the potential drawbacks before deciding if it’s the right financial tool for you. Understanding these limitations can help you make a more informed decision and avoid any surprises.
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 financial institutions 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.
Credit Utilization
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.
Bottom Line
If you decide to take out a personal line of credit, use it as a short-term solution to remedy cash flow issues. Meanwhile, 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.
Frequently Asked Questions
What is the difference between a personal line of credit and a personal loan?
A personal line of credit and a personal loan are both borrowing options, but they function quite differently. A personal loan provides a lump sum of money upfront, which you repay in fixed monthly installments over a set period. Personal loans carry fixed interest rates, meaning the interest rate remains the same throughout the life of the loan, providing predictable monthly payments.
In contrast, a personal line of credit gives you access to a pool of funds that you can draw from as needed, similar to a credit card. You only pay interest on the amount you borrow, and the credit line is typically revolving, meaning you can borrow again as you repay the balance.
Personal lines of credit usually have variable interest rates, which can change over time based on the prime rate set by the lending institution. For the most part, a higher credit score can help you get lower interest rates on both personal loans and personal lines of credit.
What is the typical interest rate for a personal line of credit?
Interest rates for a personal line of credit can vary widely, depending on your creditworthiness and the lender. Generally, they are lower than credit card interest rates but can range from around 5% to 20%.
How is the interest calculated on a personal line of credit?
Interest on a personal line of credit is typically calculated daily on the outstanding balance and billed monthly. You only pay interest on the amount you have borrowed, not the total credit limit.
Can I use a personal line of credit for any purpose?
Yes, a personal line of credit is a flexible borrowing option that can be used for various purposes, including debt consolidation, home improvements, medical expenses, or unexpected financial emergencies.
What happens if I miss a payment on my personal line of credit?
Missing a payment on your personal line of credit can result in late fees and negatively impact your credit score. It’s important to make at least the minimum payments on time to avoid these consequences.
Can I increase my credit limit on a personal line of credit?
Some lenders allow you to request a credit limit increase on your personal line of credit, especially if you have a good payment history and your financial situation has improved. You may need to undergo a credit review and provide updated financial information.
How does a personal line of credit impact my credit score?
A personal line of credit can impact your credit score in several ways. Timely payments can help improve your credit score, while high credit utilization or missed payments can lower it. Additionally, applying for a PLOC may result in a hard inquiry on your credit report, which can temporarily affect your score.
Are there fees associated with a personal line of credit?
Yes, there may be various fees associated with a personal line of credit, including application fees, annual fees, and late payment fees. It’s important to review the terms and conditions provided by your lender to understand all potential costs.
Can I convert a personal line of credit to a fixed-rate loan?
Some lenders may offer the option to convert your personal line of credit balance into a fixed-rate loan. This can be beneficial if you prefer predictable monthly payments and want to lock in a fixed interest rate.
