A personal line of credit is a flexible borrowing tool that gives you a fixed credit limit that you can draw on when you need it. This is useful when expenses are irregular or difficult to predict, such as ongoing repairs at home or inconsistent income from a freelancer.
But this flexibility goes both ways.
“Personal lines of credit typically carry higher interest rates than secured loans like mortgages or HELOCs,” said Craig Toberman, CFP and partner at Toberman Becker Wealth in St. Louis. “Rates often vary from 10 to 20% APR plus any annual fees. »
Learn more about how this type of loan works and whether an alternative might be better.
A personal line of credit, or PLOC, gives you access to funds up to a set limit. You withdraw money when you need it, usually by transferring funds to your checking account through an online portal or using checks issued by the lender. In general, no card is issued to you.
Prices often vary. So if the prime rate changes, your monthly payment and the overall cost of your loan move with it — that’s fine in a falling rate environment, but expensive when interest rates are rising.
Learn more: How the Fed impacts consumer loan interest rates
Fees also vary. Most lenders charge a monthly or annual fee, but some charge additional fees, such as:
Your interest rate may be variable, but the initial rate you receive ultimately depends on your credit scoreincome and existing debt.
A personal line of credit generally has two distinct phases:
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Drawing period: You can withdraw funds freely. Minimum monthly payments are generally required. This period can last several years.
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Reimbursement period: Withdrawals stop. Monthly payments increase because you are now repaying the entire balance plus interest.
Minimum payments on a personal line of credit are often interest-only, said Melissa Cox, a CFP at Future Focused Wealth in Dallas.
“This keeps your monthly bill low, but also keeps you in debt longer,” Cox added. “I’ve seen people wear sales for years without even realizing how much it was costing them.”
Not all lenders use the same repayment rules and terms may vary. For example, lenders may ask you to pay the greater of $50 or 2.5% of what you borrowed. Some lines of credit even require a lump sum payment at the end of the draw period, where you must pay off the entire balance at once.
That’s why it’s essential to understand your repayment terms before opening a personal line of credit.
Creditworthiness is the most important factor in getting approved for a personal line of credit. Lenders want proof that you are a responsible borrower, capable of repaying them over time.
Before applying, pull your credit reports and check your credit score. A FICO score of at least 670 or higher is usually needed to get a decent rate, although some lenders may expect a score of 760 or higher.
If your score is below 670, work on reducing existing revolving balances and eliminating late payments before applying.
In addition to your credit score and credit report, lenders also check your income, employment status and debt-to-income ratio. You will therefore need to prove that you earn enough money to repay what you borrow on time.
Banks, credit unions and some online lenders offer personal lines of credit. Popular lenders include:
If your current bank or credit union doesn’t offer a personal line of credit, you’ll need to search for one online. Typically, you must first open an account with the bank before applying.
The application process looks like apply for a personal loan or credit card. You will provide personal information such as your name and date of birth, details of your existing debts, and employment and income documents.
Most lenders make a rigorous credit check When applying for a line of credit, be prepared for a temporary drop in your score.
Review and accept the offer
Don’t rush this last step. Read each line of loan agreementin particular the reimbursement rules. If a lender doesn’t clearly explain how your payment will change over time, that’s a red flag.
Before signing, make sure you understand the following:
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Is the interest rate fixed or variable?
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How long is the drawing period?
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What happens at the end of the drawing period?
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Are there any annual or inactivity fees?
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How is the minimum payment calculated?
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Does signing up for autopay reduce my rate?
Once you accept, your credit line activates and you can begin withdrawing funds during the withdrawal period.
A personal line of credit can affect your credit score in several ways:
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Difficult investigation: When you apply, your credit report usually comes under a lot of strain, which can temporarily lower your credit score.
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Use of credit: If you use more than about 30% of your credit line, your credit score will likely suffer, and the closer you get to your credit limit, the bigger the drop. Credit usage is an important part of your credit score, so keeping your balance low is more important than the hard inquiry that comes with opening your line of credit.
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Payment history: Paying late or missing payments will quickly lower your score. Paying on time helps build credit.
When managed responsibly, a personal line of credit can really help improve your credit score. But when used irresponsibly, it can just as easily hurt you.
Learn more: 8 Common Reasons Your Credit Score Might Be Dropping
Personal lines of credit are ideal for situations where expenses are unpredictable, such as:
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Home repairs or maintenance
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Ongoing medical expenses
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Short-term cash flow gaps due to self-employment or seasonal work
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Wedding planning or the costs of a large event
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Removal and relocation costs
However, PLOCs should not be used when your budget is constantly underwater. If you treat the line of credit as a spending money bonus, you can quickly get into debt, Cox said.
“The catch is that it doesn’t feel like debt the way a loan or credit card would,” Cox added. “But over time, it’s easy to fall into a cycle where you use it more often than expected… If you don’t have a repayment plan in place, it can quickly turn into financial quicksand – easy to get in, hard to get out of.”
Need to borrow money? A personal line of credit is not your only option. Here’s how other types of loans and lines of credit compare.
Credit cards work better on your daily expenses if you are able to pay in full. You get a grace period to avoid interest and earn rewards. A PLOC charges interest immediately and offers no benefits, such as cash back or miles.
Credit cards generally have higher interest rates. PLOCs generally offer lower rates, but may also charge fees. Credit cards and personal lines of credit have limits and cost you interest when you carry a balance.
A HELOC draws on the equity in your home, making it a secured line of credit. The lender has something to take if you stop repaying, so interest rates tend to be lower than with an unsecured personal line of credit.
This lower cost, however, comes with some serious conditions. Miss enough loan payments and you could face foreclosure on your home. A PLOC doesn’t put your home at risk, but you’ll generally pay more interest.
“A personal line of credit makes more sense if you need faster approval without appraisal requirements, want to avoid putting your home at risk, or need a smaller line of credit that doesn’t warrant HELOC closing costs,” Toberman said.
Both personal loans and personal lines of credit allow you to borrow without collateral. The difference is how you access the money.
A personal loan grants you a lump sum up front. If your application is approved for $25,000, that amount is sent to your bank account and you pay it back in fixed monthly installments. It’s predictable and works well for one-time costs, but you’ll pay interest on the full amount up front.
A personal line of credit acts more like a credit card. You only take what you need and can borrow again as you repay, up to your limit.
Personal loans typically have fixed APRs, which helps make payments predictable. PLOCs typically use variable APRs tied to the prime rate, so they can start competitively but scale with the market.
If you want payment stability, personal loans are probably the way to go. If you borrow briefly and rates are stable or falling, a PLOC may be less expensive.
Learn more: Personal line of credit or personal loan: which is best for you?
