Top Uses for a Personal Line of Credit

Many people have a personal line of credit because they like its flexibility. You can borrow (and only pay interest on) as much or as little as you want, and use the money for almost any purpose. In fact, the only major exception to that is using one as a student loan, and that's only because government regulations put extra burdens on lenders if they know you're borrowing for educational purposes. That aside, your lender is unlikely to be even slightly interested in how you use your credit line, provided the use is legal.

But, of course, being able to borrow flexibly doesn't mean you should. You're very likely to be better off saving up for what you want, but even if you decide you're going to borrow, some other sorts of loans may suit some purposes better. So what are some of the top uses for personal credit lines?

1. Smoothing out cash flow

Roughly 10 million Americans were self-employed in 2013. And very few of them knew how much they'd earn from one month to the next. Worse, even when you get a regular and consistent paycheck, you're unlikely to be able to safely predict your monthly outgoings. Most households take a big and unexpected financial hit (a broken-down car that just must be fixed, the unavoidable replacement of a major appliance, essential and urgent home repairs...) every year or two. Financial uncertainty is a fact of most modern lives.

A personal line of credit can smooth out those peaks and troughs, allowing you to borrow during lean times and repay during easy ones. And, of course, unlike a personal loan, you can borrow and repay as often as you want, while only paying interest on your current balance.

2. Covering a short-term need

If you want to buy something big or cover a major expense such as a wedding, you might prefer a personal loan. It's more structured so you know precisely how much you have to pay each month and precisely when the loan will be fully paid off.

But if you need a big sum for only a short time, a personal line of credit may be better. Last year, credit counselor Mike Sullivan gave Fox Business an example: His client had a $15,000 shortfall during the few weeks between the closing on one home he was buying and on another he was selling. Few banks are interested in setting up personal loans for such short periods, and early repayment on a longer term deal might have meant a penalty. The client was considering raiding his (it was a man) retirement fund until Sullivan suggested a personal credit line would perfect. He could have the $15K for the time he needed it, and then maintain a zero balance -- with zero costs or interest -- afterwards.

Of course, most banks charge an annual fee on these credit lines, so the client would have had either to cancel the arrangement during the first year, or pay that fee if he wanted to maintain the financial cushion.

3. Avoiding putting your home on the line

An alternative to a personal credit line is a Home Equity Line of Credit (HELOC). Although HELOCs tend to have higher set-up costs, and therefore may be inappropriate for borrowing just small sums occasionally, they almost invariably come with lower interest rates, and can work out significantly less expensive over the long term.

However, HELOCs come with one big drawback: you have to put up your home as collateral. This means that, if you fall far behind with payments, you could soon face foreclosure. And, depending on your circumstances, that's a risk you may prefer to avoid. Obviously, HELOCs are available only to those who own their own homes.

4. Buying pretty much anything

A personal line of credit can legitimately be on a list of loan options for most purposes. Whether it stays on that list depends on a number of factors, but mainly cost. You need to compare different types of loans and lenders based on annual percentage rates (remember, they may be variable and go up in the future), annual fees, penalty fees and any other costs. If you're good at math, it's a good idea to model the amounts you expect to borrow and the periods over which you're likely to do so, so you know precisely how much you're going to pay.

One more thought: personal credit lines can be a lot like credit cards in that they're easy to max out. If you're bad with plastic, you might be better off choosing a fixed-term home equity or personal loan.

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