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Personal Line Of Credit Guide: How It Works, Pros & Cons

Personal line of credit (PLOC) is an unsecured loan, but it's so easy to get it. Here's how it works, benefits, risks - and how to obtain one
Author: Lorraine Smithills
Lorraine Smithills

Writer, Contributor

Experience

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
Interest Rates Last Update: April 15, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Lorraine Smithills
Lorraine Smithills

Writer, Contributor

Experience

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
Interest Rates Last Update: April 15, 2024

The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.

You can trust the integrity of our unbiased, independent editorial staff. We may, however, receive compensation from the issuers of some products mentioned in this article. Transparency is a core value for us, see how we make money.

Table of Content

If you’re considering a significant purchase or need funds for another purpose, you may have considered a personal line of credit. 

How Does Personal Line of Credit Work?

A personal line of credit is an unsecured loan, so you don’t need collateral to qualify. As with credit cards, personal lines of credit typically have an adjustable interest rate, a set credit limit, and a fixed payment schedule. In most cases, you will only be able to obtain a personal line of credit if you’re already a customer with a specific lender.

For example, you may only qualify for the best terms if you already hold a checking or savings account with a bank. However, if you are eligible, you could obtain a credit limit of $1,000 to $100,000 or possibly more if you have substantial holdings with the financial institution.

A personal line of credit differs from a basic personal loan because you can call down the funds within your agreed limit as and when you need them. In addition, some lenders allow an open-ended agreement with no set date for accessing your credit.

Benefits & Risks of a Line of Credit

Generally, lines of credit are not intended to fund a one-time purchase such as a car or house, there are specially designed loans for these purposes. However, a line of credit can be useful for purposes that a bank may not typically underwrite a loan.

As with any financial product, there are potential drawbacks associated with lines of credit that you should consider before making a final decision.

The benefits and risks of a line of credit include the following:

You can use a line of credit to even out variable income and expenses. 

For example, if you’re self employed and have an irregular monthly income or a delay between working and collecting the resulting payment, a line of credit can be a less costly and more flexible way to deal with a cash flow issue rather than relying on credit cards.

A personal line of credit can be a good option if you want to finance a project, but are struggling to calculate the exact funding you’ll need. 

Since you can use the funds for almost anything, you can have access to the money you need without worrying about bank underwriting.

One of the most attractive benefits of a personal line of credit is that you only pay interest on the money that you’ve borrowed.

 If you’re using the line of credit for a project, you don’t need to start paying interest on the full amount immediately, as you would with a personal loan. 

You can simply call down funds as and when you need them, and only at this point will you start incurring interest charges.

Since you only start making repayments when you call down funds, and the amount you need to repay will vary, it can make predicting your future payments a little tricky. 

Unlike a personal loan, where you know how much you will be repaying each month and can budget accordingly, you will need to think ahead to ensure that you remain comfortable with your repayment commitments before calling down funds.

Some lenders impose application, maintenance, and withdrawal fees, which you will need to consider when you’re comparing finance options.

Since you can call down funds up to your agreed limit, there may be an increased temptation to overspend

A personal line of credit can be used a little like a credit card, and you may not realize how much you’ve spent until you check your statement.

Personal Line of Credit: Repayment Structures

While most personal lines of credit function like a credit card, other repayment structures may have different provisions.

  • Revolving Credit: This is the standard repayment structure for a personal line of credit. It allows you to draw funds up to your agreed limit. You can borrow funds as needed without taking the total amount in one payment. When you call down funds, you’ll need to make monthly payments to repay the credit.
  • Designated Draw and Repayment Periods: Some personal lines of credit feature separate draw and repayment periods. This allows you to withdraw funds during your draw period and then make monthly payments during repayment.
  • Demand Line of Credit: This is a rare form of personal line of credit, but some banks will offer this type. Essentially, it acts as a standard line of credit, but there is a provision for the lender to call for loan repayment at any point.
  • Balloon Payment: As the name suggests, this type of personal line of credit requires payment of the entire balance at the end of the agreed term. Balloon payments often have the added need to organize refinancing if you are unable to repay the total amount.

Fees Charged With a Personal Line of Credit

In addition to the interest charges on the amount you borrow, the fees associated with personal lines of credit vary from lender to lender. However, there are some common fees that you will need to check before you finalize any agreement.

  • Annual Maintenance Fee: As the name suggests, this is a fee the lender imposes each year for maintaining your account. You could incur this fee even if you currently have not borrowed any funds.
  • Late Payment Fees: If you don’t make your scheduled payment on time, you could incur a late payment fee. This may be a set amount or a percentage of the past due payment.
  • Returned Payment Fees: If your payment cannot be processed and applied to your account, you may incur a returned payment fee. This is pretty standard, and you can incur returned payment fees as you would if your check does not clear when you pay your credit card bill.
  • Prepayment Penalties: If you want to repay your personal line of credit in full before the agreed date, your lender may impose a prepayment penalty. These fees are typically a percentage of the outstanding balance, but they may be a flat fee.

How to Get a Personal Line of Credit?

Applying for a personal line of credit is similar to applying for any type of loan. There are several steps involved in the application process.

  • Check your Credit Report: Since personal lines of credit are typically unsecured loans, a potential lender will look at your credit profile, including your credit score, credit history, income, current debt, and other factors to determine your ability to repay the loan. Before applying, it is a good idea to check your credit report for any red flags that may impede your application.
  • Research Lenders: The next step is researching some lenders to compare quotes. Fortunately, many online platforms allow you to compare rates and deals without a hard credit pull. This will allow you to check how much you could borrow and the type of payment requirements involved.
  • Check Fees and Charges: While you’re comparing deals, be sure that you check the fees and charges associated with each lender and line of credit. As we discussed earlier, some lenders impose annual fees, maintenance fees, and other charges. So, it is essential to look at the potential costs rather than just looking at the interest rates.
  • Prequalify: If you find a deal you’re interested in, it is a good idea to see if you can prequalify. This will involve completing an application form with basic information. You can typically get a reply quickly and then determine if you want to proceed with a formal application.
  • Complete a Formal Application: You can then go ahead to complete your formal application. You will need to submit documentation to support your application. At this stage, the lender will perform a hard credit pull. The application process can vary from lender to lender, but once approved, you can start to access your line of credit.

Where to Obtain a Personal Line of Credit?

While personal lines of credit are not as common as personal loans, you can still obtain them from a number of financial institutions. These include:

  • Banks: National and smaller regional banks may offer personal lines of credit. However, there are often some requirements. For example, you may need to be an existing client with some form of financial account already in place, such as a checking or savings account. You may also need to live near a local branch.
  • Online Lenders: Many online lenders have extended their product lines to offer personal lines of credit. Online lenders typically have more lenient lending requirements, and you can generally access funds quickly. However, online lenders may only provide personal lines of credit in a few states, and they may offer lower credit limits.
  • Credit Unions: You will likely need to be already a member of a credit union to access a personal line of credit. You may need to hold a minimum of a savings account to maintain your membership status. However, since credit unions are not for profit, they are less likely to impose application fees or annual fees.

How to Shop Around Smartly For PLOC?

As with any financial product, it is a good idea to shop around before you commit to a personal line of credit. There are several smart tips to help you ensure that you get the best deals.

  • Compare Rates: It is good to compare multiple deals to see which lenders offer the best rates. There are online comparison tools that allow you to check various lenders. You need to enter some basic details and your desired amount. The comparison site will then present you with the available deals to suit your financial circumstances so that you can check the rates.
  • Check With Your Current Bank or Credit Union: Many financial institutions will offer their clients more flexible lending requirements and advantageous terms. So, before you commit to any personal line of credit deal, speak to your current bank or credit union to see what they could offer you.
  • Gather Your Paperwork: If you decide to go ahead with a deal, you’ll need to support your application with documentation to confirm your identity and address. You may also need to confirm your income and employment status. If you gather all the necessary paperwork in advance, you won’t cause a delay when it comes time to apply.
  • Review the Terms and Conditions: All lenders have their terms and conditions, so you must review the specific terms and conditions before you commit to a deal. The terms and conditions will detail potential fees, withdrawal restrictions, and repayment terms. This will ensure you are entirely comfortable with all aspects of the deal.
  • Double Check the Alternatives: Double-check your finance alternatives before finalizing any personal line of credit. Confirm that the personal line of credit offers better terms for your circumstances than personal loans and other financial products.

Unsecured vs. Secured Lines of Credit

As with other types of finance, there are both unsecured and secured lines of credit. While many lenders consider a personal line of credit an unsecured form of finance, some offer secured options.

The main compromise with a secured line of credit is that since you’re providing collateral, there is less risk for the lender. This is typically reflected in better terms.

If you opt for a secured line of credit, you may be able to qualify for a lower rate or a larger credit limit. The downside is that your collateral is at risk if you fail to adhere to the agreed payment structure.

If you have less than perfect credit, a secured line of credit may be a better option. With an unsecured agreement, you could qualify for a lower interest rate or a larger credit limit that would not be available to you.

However, suppose you have strong credit and don’t want the delays involved in appraising a potential asset for collateral. In that case, an unsecured personal line of credit is likely best for you.

Does a Personal Line of Credit Affect My Credit?

Credit reporting agencies typically track personal lines as revolving credit. In this way, they are like a credit card account. Since it is revolving debt, your balance and maximum credit line will impact your credit utilization ratio.

So, if you haven’t called down any funds, you will show as having the total amount as available and unused on your credit report. However, as you call down funds, it will alter your credit utilization percentage.

Your payment history will also be reflected on your credit report. So, if you manage your account responsibly, it could help your credit score, but if you have missed or late payments, there could be a detrimental effect.

If you have a long-standing line of credit account, it will also add to the length of your credit history, but a new account will shorten your overall account history record.

Another factor that could impact your credit score is that personal lines of credit are becoming less common. If your bank stops offering them and closes your account, it will reduce your available credit and increase your credit utilization ratio.

So, like any form of credit, a personal line of credit could positively or negatively impact your credit, depending on how you manage your account. 

This chart created with Experian data shows that those with an average to good credit score have an average credit utilization ratio of the optimum 33%. This ratio drops significantly for those with very good and excellent scores.

At the other end of the scale, the chart shows that those with poor credit scores typically have a very high credit utilization ratio, with an average of 73%. This will be a massive factor in lending decisions for those in this group.

 

Personal Line of Credit Alternatives

While there are many similarities between a line of credit and other finance options, some key differences may influence whether an alternative is a better choice for you. Some of the common personal line of credit alternatives include:

1. Credit Cards

As with a line of credit, you’ll have a preset limit with a credit card, and you can access the funds as and when you like. Your credit card account may also be subject to an annual fee. Your credit card limit will be determined by the issuer, and there may be some incentives for using your card to purchase particular categories of items.

Credit cards offer a flexible repayment schedule. There is a minimum monthly payment, but you are free to pay more than this amount or pay the bill in full every month. You can incur late payment fees if your payment is not applied to your account before the due date, and some companies impose an interest rate penalty if accounts are not responsibly managed.

The main advantage of a personal line of credit over credit cards is that you need to be a little more deliberate in accessing the funds. You will need to request funds rather than simply swiping a card when you make a purchase. This could help to avoid overspending.

2. Unsecured Loans

We’ve already touched on the similarities between unsecured personal lines or credit and unsecured loans. However, there are some crucial differences.

Firstly, unsecured loans provide a lump sum in one payment. You’ll have a prearranged payment schedule, and your repayments typically start four to six weeks after receiving the funds.

Unsecured loans are typically a better option than a personal line of credit if you make a significant purchase for a set amount. One of the benefits of personal loans is that you can receive the funds to make your purchase and then have a set repayment amount each month. This allows you to budget for your repayments as the same amount is billed every month until the end of the loan term.

However, a personal line of credit would be better if you’re not making a single purchase and are unsure how much money you will need. You can call down the funds when you need them, and you will only pay interest on the borrowed money.

3. Home Equity Loan

A home equity loan allows you to borrow against the equity you have accumulated in your home. Many lenders will let you borrow up to 80% to 90% of the value of your home, less any existing mortgage or home loans. You can opt for a longer repayment period of as much as 20 years, so you can spread out the cost of your loan to reduce your monthly repayments.

With a conventional home equity loan, you’ll receive a lump sum and begin paying interest immediately. However, there are home equity lines of credit, which operate similarly to personal lines of credit, except that they are secured on your home.

In either scenario, the loan or line of credit is secured on your home, so a home appraisal is included in the application process. This can extend the timeframe from application to receipt of funds. However, since the finance is secured, the rates are usually lower.

So, if you need access to the funds quickly and are prepared to pay a higher rate, a personal line of credit would be the better choice.

4. Retirement Fund Borrowing

Retirement fund borrowing or a 401k loan allows you to borrow against the funds in your retirement plan.

These loans typically have no minimum credit score requirements, and the application process tends to be far more straightforward, with no need to submit support documentation. Retirement fund borrowing tends to be a good option if you may struggle to meet traditional lender loan requirements.

However, there are tax implications of retirement fund borrowing. You’ll pay income tax when you withdraw the funds from your fund. You may also incur an additional tax burden if you leave your current employer while the loan is still active. Additionally, there is a loss of earnings on those funds, which could impact the overall performance of your retirement fund.

FAQs

This depends on the lender. Some lenders allow you to access the funds within one day of your application being approved. However, some lenders are a little slower. You’ll need to check the timeframe for your specific lender.

Personal lines of credit tend to have a variable rate, which means that the cost of borrowing will increase as the base interest rate goes up in response to rising inflation. However, if you’ve arranged a fixed rate line of credit, your rate will not increase, regardless of inflation.

If you are planning a project where you’re not sure of the final costs or you may need to compensate for fluctuating income, a personal line of credit can be a good option. However, if you’re planning a purchase with a fixed sum, a personal loan may be a better option.

A personal line of credit is a loan, but it only kicks in when you have requested funds. If you don’t call down any funds, it is merely a facility in place should you need it.

Picture of Lorraine Smithills

Lorraine Smithills

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
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