What Is a Personal Line of Credit?
A personal line of credit isn’t easy for everyone to qualify for — they are often exclusive to high-net-worth consumers or bank customers with significant assets already at the institution.
But, if you are able to qualify for a personal line of credit, it may provide a solution to help smooth out life’s periodic mismatches between income and expenses.
What is a personal line of credit?
A personal line of credit is money you can borrow on demand for a prescribed period of time. This borrowing tool could be considered a cross between a personal loan and credit card.
How does a personal line of credit work?
A personal line of credit operates similarly to a home equity line of credit (HELOC), but a personal line of credit is not secured by the equity in your home. A personal line of credit is typically unsecured, although some lenders may require you secure the credit line with some form of collateral, like money in a savings account or an asset.
With a personal line of credit, you can make withdrawals up to the approved limit as you wish. Your lender only charges interest on the amount you use from the line of credit, and you only have to pay back what you use (with interest, of course). If you use the line of credit, you’ll receive a monthly bill with a required minimum payment. Your lender may also charge an annual fee to maintain the credit line.
Although personal lines of credit are revolving lines like a credit card, some lenders apply a limited withdrawal period to the line of credit. After the withdrawal period on the line of credit ends, you won’t be able to take out any more money. At that point, you enter a repayment period and will be required to make monthly payments to repay what you’ve used. You may also have the option to renew the line of credit for another withdrawal term. On the other hand, open-ended lines of credit require payments as you use the line, much like a credit card.
Where to find a personal line of credit?
You can find personal lines of credit through a bank or a credit union. Consumers with strong credit histories will have the best shot at getting approved for a lender’s lowest rates on a personal credit line. The institution may also require you to have an open account with them in good standing. Some institutions may also require you to have a certain amount of money on deposit before you can take out a personal line of credit.
Personal lines of credit may have fixed or variable interest rates. If the credit line has a variable interest rate, the amount of interest you’re charged may change from month to month. The interest rates charged on personal lines of credit vary widely by lender.
Lenders may offer secured or unsecured personal lines of credit. You may have the option to secure the loan with assets in a certificate of deposit (CD) or another savings vehicle. With some lenders, opting for a secured loan may grant you a lower interest rate or higher credit limit. Some even offer interest rate discounts on personal lines of credit to borrowers who make automatic payments from another account at the institution.
When you’re looking for a personal line of credit, you should be careful to compare the terms you are offered from multiple lenders. You should compare the following before making a final decision:
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- Annual percentage rate (APR) charged on credit balances
- Frequency with which the interest rate can be reset
- Amount by which that interest rate can be reset
- Fees for initiating the line of credit
- Fees for accessing the line
- Amount and reason for any other fees
Who is a personal line of credit best for?
A personal line of credit is ideal for those who may need an occasional cash flow injection to cover their expenses.
If you earn commision or are a contracted worker like a freelancer or an actor, for example, you may have an irregular income stream. And although you may earn enough money to cover your expenses over the course of the year, you might not have the cash you need on hand from month to month — you could use a personal line of credit to make sure your bills are covered while you await payment.
A personal line of credit may also prove useful if you are facing a series of unusual or unpredictable expenses that you can’t cover right away with your normal income, like expenses associated with a short-term medical issue.
Whether a personal line of credit is the best borrowing tool for your needs will depend on several factors, such as the cost of the loan, your available alternatives and whether you are confident in your ability to repay what you borrow.
Alternatives to consider
As with any financial decision, it’s smart to comparison shop, while also looking at alternatives to the product you’re looking at. You may consider using a one-time personal loan, a HELOC or a credit card as an alternative to a personal line of credit. Here’s a breakdown of each option.
Personal loan
A personal loan is a fixed amount of money borrowed at a fixed rate. You receive the loan in a lump-sum cash payment and repay it in equal installments spread out over a fixed loan term.
How it works
A personal loan can be secured with an asset or unsecured. The more popular option is the unsecured personal loan. The loan funds can be used for a variety of purposes like going on a vacation, paying for a wedding or consolidating debt.
Borrowers must generally have at least a good credit score on the FICO scale, low debt-to-income ratio and consistent income to qualify for a personal loan. Some lenders consider other factors, like your education level and work experience, too. Those with the highest credit scores and lowest debt-to-income ratios may qualify for more favorable terms, like a lower interest rate.
Who it’s best for
When you take out a personal loan, you get all of the cash at once, but you’ll also need to begin paying back the full amount of the loan right away in fixed monthly installments. This arrangement may be convenient for those who need the entire loan amount and want to budget for more predictable, fixed monthly payments.
If you don’t need all of the cash at once, a personal line of credit may prove more convenient than one-time personal loan, as you’ll have access to the full limit if you need to use it, but you will only be required to pay back, with interest, what you use while the line is open.
Where to find one
You can get a personal loan from a bank, credit union or online lender, and you should shop around to find your best offer. You can start the personal loan comparison process right here on LendingTree.
Home equity line of credit (HELOC)
A home equity line of credit, or HELOC, is a line of credit secured by the equity in your home. The credit line is also commonly referred to as a second mortgage.
How it works
Homeowners generally may borrow up to 85% of the appraised value of their home using a HELOC. However, the amount you are approved to borrow will depend on factors such as the amount you’ve already paid into your mortgage, your creditworthiness and other outstanding debts.
Like the personal line of credit, the HELOC has a fixed draw period, during which you can withdraw funds from the line of credit, up to your limit. You will need to make minimum interest payments on the amount you’ve borrowed. After the draw period ends, you may be eligible for renewal, or you may enter a repayment period and begin paying back what you’ve borrowed with interest. The HELOC generally charges a variable interest rate that’s tied to the U.S. prime rate.
You may have to pay closing costs (like the home appraisal, application fee and attorney’s fees) on a HELOC, which you won’t have to pay on a personal line of credit. However, HELOC closing costs are generally less expensive than those on home equity loans, and there are no-closing-cost HELOCs. There may also be fees associated with each draw from the line of credit.
Who it’s best for
Because the HELOC is backed by the equity in your home, you run the risk of losing your home if you’re unable to make payments. However, having the collateral backing the line of credit could mean you pay a lower interest rate on the amount you borrow, compared to the rate you’d pay on a personal line of credit.
Where to find one
Many mortgage lenders offer HELOCs. You can use tools from LendingTree to calculate your home equity and compare the terms on HELOC offers.
Credit card
A credit card grants its holder access to a revolving line of credit they can borrow from and use to pay for just about anything. Many lenders reward cardholders who have specific credit cards with cash back or other rewards when they repay their balances on cards.
How it works
With a credit card, you can spend up to your limit and repay your entire balance, the minimum monthly payment or something in between. If you don’t repay the entire balance on the credit card within the monthly statement period, the credit card company charges interest on the unpaid balance, which is then added to your overall balance (aka capitalized interest). If you pay for what you’ve charged within the statement period before the period ends, you avoid paying interest.
As of this writing, the Federal Reserve reports the average rate charged on a credit card is 16.46% APR.
Who it’s best for
Credit card offers exist for borrowers with any credit score, though some items in your credit history (like a recent bankruptcy) could keep you from getting a credit card. Borrowers with the best credit scores are generally offered the lowest interest rates, and are more likely to be approved for cards with rewards and promotional offers like 0% APR on purchases and/or balance transfers for a limited period of time.
You might qualify for a lower interest rate or higher credit limit on a personal line of credit than you would on a credit card. However, if you have good enough credit to qualify for a good rate on a personal line of credit, you’re likely able to qualify for a credit card with rewards or a promotional offer that makes the credit card more appealing than the line of credit. Like some personal lines of credit, some credit cards have annual fees.
Where to find one
You can check out our credit card marketplace to see, sort and compare the best credit card offers currently available from our partners.
Is a personal line of credit right for you?
Although it may prove difficult to qualify for a personal line of credit, having access to cash when you need it, without worrying about applying for new credit and possibly dinging your credit score, may help to put your mind at ease. The product can act as a safety net for those with inconsistent income or as an emergency fund for parents or homeowners who may not always be sure they’ll have the cash on hand if a costly emergency strikes.
