A personal line of credit may be a valuable resource to cover unanticipated costs, urgent reparations, or temporarily bridge financial deficiencies. In addition, this type of indebtedness allows access to a reservoir of resources that can use to withdraw cash whenever necessary.
Comparable to a credit card, a personal credit line allows one to withdraw funds during a designated draw period and repay the borrowed amount. However, once this period concludes, the option to make further withdrawals ceases, and it becomes necessary to reapply to maintain the personal line of credit.
What is a personal line of credit?
A personal line of credit, commonly called PLOC, is an unsecured revolving account featuring a variable interest rate. Like a credit card, it allows borrowers to draw from the funds as necessary and repay them with interest. PLOCs may serve as an effective strategy for regulating daily cash flow, particularly for individuals with unpredictable earnings or confronted with sudden expenses.
Personal lines of credit commonly have comparatively reduced interest rates compared to credit cards, making them more cost-effective for substantial cash advances. Nonetheless, due to their unsecured nature, they are most suitable for consumers possessing a solid credit history.
How does a personal line of credit work?
Upon receiving approval for a personal line of credit, borrowers can gain entry to the funds through a revolving line of credit. These funds may be accessed through multiple channels, such as visiting a local branch of the lending institution or initiating a transfer through a mobile application. However, every withdrawal necessitates repayment with interest, which varies depending on the market — implying that the interest rate may fluctuate.
Throughout this period, borrowers can continue to borrow and repay funds from the line of credit if they don’t exceed the credit limit. However, when the two-year draw period concludes, they must reapply to maintain the lending institution’s credit line.
Personal lines of credit vs. personal loans
Compare to a PLOC, a personal loan is an unsecured loan that can provide you with the necessary funds. However, there are some notable differences between the two. While both require a hard credit check for approval and come with interest rates, personal loans usually have a fixed interest rate and a predetermined repayment term. This means you’ll make regular payments over a period until the loan is paid off. On the other hand, a PLOC allows you to borrow and repay funds as needed with a variable interest rate and no fixed repayment term.
When approved for a personal loan, you will receive the entire loan amount in a lump sum and will be required to make monthly payments over a fixed term. This means that you will be charged interest on the entire loan amount, not just the amount you borrow at any given time, as with a personal line of credit.
It’s important to note that personal loans typically have a fixed interest rate, which is often lower than the variable interest rate on a personal line of credit. This makes the monthly payment on a personal loan predictable and more accessible to budget for compared to a personal line of credit.
Types of lines of credit
Various lines of credit (LOCs) are available, and a personal line of credit is just one of them. Each type of LOC comes with its advantages and disadvantages. By assessing your financial situation and the features of each kind of LOC, you can decide which one suits your needs the best.
Personal lines of credit
If you need to cover unexpected personal expenses quickly but need collateral like a house or car, a personal line of credit (PLOC) may be the best option. However, PLOCs are usually granted to individuals with good or excellent credit histories, as the lender relies on your promise to repay what you borrow with this type of LOC.
Business lines of credit
A business line of credit (BLOC) and a personal line of credit (PLOC) operate similarly, as you will receive a credit limit that you can use and repay as needed. However, a BLOC may have higher limits and is specifically designed for business use. Companies may utilize a BLOC for various purposes, such as buying equipment, managing short-term cash flow issues, etc.
Home equity lines of credit
A home equity line of credit (HELOC) loan allows you to borrow money based on the equity you have in your home. The amount you can borrow is determined by the difference between your home’s current market value and the remaining balance on your mortgage.
Unlike personal lines of credit, HELOCs have secured loans, meaning your home is used as collateral. If you fail to repay the loan, you could risk losing your home through foreclosure. However, because you are using your home as collateral, interest rates for HELOCs are often lower than those for unsecured personal lines of credit.
Types of repayment for a personal line of credit
A personal line of credit is a temporary borrowing option. When you apply for a personal line of credit, you will be given a specific period during which you can withdraw funds, known as the draw period. You will enter a repayment period if you still have an unpaid balance on your personal line of credit when the draw period ends.
Different lenders may have varying terms for repayment of personal lines of credit. Some types of repayment may include:
Draw and repayment periods: ThisThe most common type of repayment for a PLOC is the monthly payment method, which has been described earlier. During the repayment period, you’ll usually be required to make monthly payments.
Balloon payment: You will be required to pay off the entire remaining balance in a lump sum at the end of the draw period.
Demand line of credit: Some lenders may set up a PLOC as a demand line of credit, which is uncommon. This means that the lender can demand full repayment at any time.
Pros and cons of personal lines of credit
A personal credit line proffers several boons compared to other rapid forms of capital, yet some individuals may have better options. Therefore, before application, it is paramount to scrutinize both the merits and demerits of this approach.
Pros of personal lines of credit
- A personal line of credit allows for swift access to funds, enabling you to borrow money at any point within your designated draw period. Depending on your lender, you can access this line of credit either through your bank branch, online, or via a mobile app.
- Sometimes, banks offer the option to use a personal line of credit as overdraft protection for your account. This provides security and peace of mind, mainly if you frequently write checks or have concerns about over-drafting your account.
- Personal lines of credit often boast more competitive interest rates than credit cards. However, it’s worth noting that the specific interest rate on your PLOC will depend on both your lender and your individual credit history.
- If you do not have a car or a home to put up as collateral, a personal line of credit could be an excellent option for obtaining funds. Unlike other forms of credit, such as home equity lines of credit, a PLOC does not require collateral.
- With a personal line of credit, you are only required to pay for the amount of money you have borrowed plus the interest on that amount. You can only pay something once you make a draw on your funds. This means that you can withdraw any amount within your approved limit, and you will only be charged interest on the amount you have borrowed, not on the entire credit line.
Cons of personal lines of credit
- The interest you pay on a personal line of credit is not tax-deductible, meaning opening a PLOC may involve an additional cost.
- Interest on a personal line of credit is not tax-deductible, meaning you cannot reduce your tax bill by deducting the interest paid on your PLOC. This adds an extra cost to opening a PLOC.
- Obtaining a PLOC can be difficult if you have a poor or limited credit history. In addition, since a PLOC is an unsecured line of credit, the lender relies solely on your promise to repay the borrowed amount.
- With a PLOC, you can borrow up to your credit limit during the draw period. However, when the draw period ends, you must repay the amount borrowed plus any interest accrued. If you do not have a repayment plan, you may end up over-borrowing and struggling to make payments.
How to find the best personal line of credit
To be eligible for a personal line of credit, you typically need two main things: a good credit score and a strong credit history.
A personal line of credit typically has higher interest rates than a home equity line of credit (HELOC) since PLOCs are unsecured. However, they still offer lower rates than options like credit card cash advances or payday loans.
It is recommended to check with multiple lenders to compare and find the one that offers the best terms for your line of credit. Factors to consider include interest rates, repayment terms, and the length of the draw period. By comparing different lenders, you can find the best deal and ensure you get the most out of your line of credit.
To apply for a personal line of credit (PLOC), you must follow a similar application process as with any other loan, which can typically be done online. After you have selected a lender and the credit limit you want, you will need to provide personal information such as your name, Social Security number, employment history, and income details.
Where to get a personal line of credit
Traditional banks, credit unions, and online lenders offer personal lines of credit. You can start by applying with an existing relationship with a bank or financial institution. Still, you may also want to shop around to ensure you get the best interest rate and terms for your financial needs.
If you want to apply for a personal line of credit at a credit union, you may need to become a member first.
Alternatives to a personal line of credit
Balance transfer credit cards offer an interest-free period, usually lasting between 12 and 21 months, during which you can transfer a balance from one card to another. You can effectively get an interest-free loan if you pay off the balance in full before the promotional APR window ends.
Home equity loans and home equity lines of credit (HELOCs) allow you to borrow money by using the equity you have in your home as collateral. These types of loans can give you access to a substantial amount of cash, as most lenders will allow you to borrow between 75 to 85 percent of the equity in your home.
If you have a 401(k) retirement plan with your employer, you can take out a loan against the balance. This option has less stringent income and credit score requirements, making it easily accessible. The interest you pay on the loan also goes back into your retirement account.
A personal line of credit works similarly to a credit card, allowing you to access funds as needed and repay them revolving. There are several benefits to borrowing money through a personal line of credit, including quick access to cash and more favorable interest rates than credit cards.
However, remember that a personal line of credit is not suitable for everyone. You must have a strong credit history to qualify. If you have an account using credit irresponsibly, there is a risk of overborrowing if you apply for a personal line of credit and shop for the best interest rates and terms that suit your financial needs.