A personal line of credit can smooth out the cash flow problems that occasionally afflict most households. You must surely have been there: some major expense arises unexpectedly, or there's a sudden, short-term drop in income. For some (small business owners, freelancers, self-employed consultants and so on), income frequently swings alarmingly from month to month, and periods of financial feast and famine are the norm. Of course, ideally, those famines would be cushioned by savings. But few of us lead ideal lives.
What Is a Personal Line of Credit?
A personal credit line is a flexible loan, usually obtained from a bank or credit union, that's designed to provide an alternative cushion against cash flow fluctuations when a borrower wants to leave savings untouched -- or has none. The lender sets a credit limit, and the consumer can draw down -- and repay -- money whenever he or she chooses, although that limit must be respected and minimum monthly payments are required when there's a balance.
You can see that in many respects these credit lines are a lot like credit cards: they provide the flexibility to access funds when needed, and the credit may be used and repaid as many times as you want as long as the account remains open and in good standing. However, they don't automatically come with plastic, although some may be tied to a checking account and so can be accessed with a debit card.
Credit cards may share many characteristics with personal credit lines, but home equity lines of credit (HELOCs) are even more similar. In fact, the only major difference is that HELOCs require you to put your home on the line when you use them. That means they (HELOCs) are obviously not an option for those who aren't homeowners.
Pros of a Personal Line of Credit
There are plenty of things to recommend personal credit lines:
- They're usually (though not always) cheaper than credit cards, at least when you compare both products for borrowers with the same credit score. In other words, they tend to charge lower annual percentage rates (APRs).
- Unless they're linked to a checking account and debit card, they may provide fewer temptations than credit cards when it comes to making impulse purchases and deciding on the acceptable price for an item.
- Depending on the credit limit requested, applications can often be processed quickly, and money may be available in days rather than weeks -- or, in the case of HELOCs, possibly months.
- Compared to HELOCs, the cost of setting up the facility is almost bound to be much lower.
- Again unlike HELOCs, these are unsecured, which means the chances of your losing your home if you default are remote.
- Compared to traditional personal loans, they're much more flexible: you only borrow what you want when you want to, and you can reuse the same credit as many times as you want.
- You can use them for any purpose.
Cons of a Personal Line of Credit
Before you apply for a personal line of credit, you need to be aware that:
- HELOCs almost always have lower APRs. That's because the lender has less risk: it can foreclose on your home if you fall far enough behind on payments.
- Fees and APRs vary widely between lenders. As with all borrowing, you need to shop around for the best personal loan rates.
- These products aren't regulated in the same way credit cards are. Make sure you check penalty fees and rates, such as those for going over your limit or making late payments, when you're comparison shopping.
- Nearly all of these come with adjustable interest rates, meaning the lender can increase your APR, and therefore your monthly payments, in the future. Unlike credit cards, personal lines of credit rate increases can be applied to existing balances as well as new charges, so there's a real risk of a previously affordable loan becoming difficult to maintain. Check each lender's offer to see how often and by how much it can increase your APR.
- While they don't provide quite the immediate temptations of a credit card, credit lines still cause some to overspend. If you're the sort of person who always maxes out your plastic, you may do the same with this credit line.
There's no such thing as a financial product that suits all borrowers in all situations. Personal credit lines can be ideal for some, but worse than bad for others. All you can do is line up the pros and cons for each type of loan and then find the one that aligns best with your personal circumstances and characteristics.
One thing remains true in almost all situations: get your borrowing in place before you need it. Whether you're applying for a line of credit, a loan or a credit card, one of the things lenders find least attractive is the slightest hint of desperation.