What is a personal line of credit and how does it work?

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If you are looking for a way to pay for emergency repairs, unexpected expenses or manage cash flow temporarily, a personal line of credit could be the right tool for you. A personal line of credit is a temporary credit account with a specified limit. With this type of credit, you can borrow the amounts you need as you wish instead of getting a lump-sum amount.

What is a personal line of credit (PLOC)?

A personal line of credit (PLOC) is an unsecured revolving account with a variable interest rate.  It’s a type of loan you can draw from as needed and pay back with interest, much like a credit card. It can be a viable option to help manage your daily cash flow, especially if you have an irregular income or are faced with an unexpected expense.

PLOCs generally have lower interest rates than credit cards, so they’re typically cheaper for big cash advances. However, because PLOCs are unsecured, they’re best for consumers with a strong credit history. This means that a PLOC might not be the best option for everyone.

“You generally need good credit to qualify for a PLOC (say, 680-plus on the FICO scale) because this is unsecured credit,” says Ted Rossman, industry analyst at CreditCards.com. “You’re not putting your home, car or any other collateral on the line.”

How does a personal line of credit work?

A personal line of credit operates much like a credit card.

“You would go and apply for a line of credit in whatever amount you need, but you don’t walk out of the bank with a check,” says Adam Marlowe, principal market development officer for Georgia’s Own Credit Union. “You access the money as you need to use it, and your repayment is based on what you’ve used.”

Once approved for a PLOC, you have access to funds via a revolving line of credit. That money can be tapped in various ways, such as withdrawing it at one of the lending institution’s local branches or initiating a transfer via a mobile app. Every draw will have to be repaid with interest, which is variable — meaning your interest rate will rise and fall based on market fluctuations.

It’s also important to note that most PLOCs have an expiration date.

“For instance, if you need a $3,000 line of credit, we’ll grant that line of credit and it’s good for two years,” Marlowe says. “You have an open revolving line of credit for $3,000 for two years.”

During that time, you can keep borrowing from and repaying the line of credit, up to the line’s limit. But at the end of two years, in order to continue to maintain the line of credit, you’d have to reapply with the lending institution.

Types of repayment for a personal line of credit

Personal lines of credit are only temporary. When you apply for one, you will usually be given a specific time period for when you may withdraw funds, called a draw period. If you still have an unpaid balance on your personal line of credit when the draw period ends, you will enter what is called a repayment period.

During the repayment period, you will have to pay off any remaining balance. However, different lenders may have different terms for repayment. The various types of repayment may include the following:

  • Draw and repayment periods: This is the most common type of repayment used for a PLOC as described above. Typically, monthly payments are required during the repayment period.
  • Balloon payments: This type of repayment requires that the full balance is paid at the end of the draw period.
  • Demand line of credit: While not very common, some lenders may set up a PLOC as a demand line of credit. This means the lender has the right to ask for full repayment at any time.

When setting up your personal line of credit, make sure you understand the repayment terms with your lender. Be sure to make a plan for repayment.

Pros and cons of personal lines of credit

A personal line of credit has several advantages when compared to other sources of fast capital, but it’s not the right choice for everyone. Consider both the benefits and drawbacks before applying.

Pros of personal lines of credit

  • Quick access to funds: With a personal line of credit you can borrow money at any time during your draw period. You can access the line of credit through your bank branch, online, or with a mobile app depending on your lender.
  • Overdraft protection on some accounts: If you are worried about overdrafting an account, some banks will let you use a PLOC as overdraft protection. This can offer you security if you often write checks or worry about overdrafting your account.
  • Competitive rates compared to credit cards: A personal line of credit typically has lower interest rates than a credit card. Although, the rate on your PLOC will vary depending on your lender and your personal credit history.
  • No collateral required: While other options like home equity lines of credit use your home equity as collateral, a PLOC does not require any collateral. So, this can be a great option if you don’t have a home or a car to use as collateral.
  • Only pay for the draws that you make: With a PLOC, you don’t have to pay anything until you make a draw on your funds. You can withdraw funds of any amount within your limit and you only pay for the amount you have withdrawn plus interest.

Cons of personal lines of credit

  • Higher rates than HELOCs: A HELOC is considered a secured line of credit since your home is used as collateral for the amount you owe. But, a PLOC is considered unsecured since it does not have collateral. This means the interest rates will likely be higher with a PLOC.
  • Interest isn’t tax-deductible: You cannot deduct the interest on a line of credit from your taxes. This adds an extra cost to opening a PLOC.
  • Hard to qualify with poor credit and/or limited credit history: Without any collateral on a PLOC, the lender must take your word that you will pay back what you use. This means they are less likely to grant you a PLOC if you have poor credit history.
  • Risk of over-borrowing: You can borrow up to your limit on your PLOC throughout the draw period. However, when the draw period ends, you must repay what you have used completely plus any interest that has accrued. If you do not have a plan for repayment, you can risk over-borrowing.
  • Variable interest rates: Typically a PLOC has a variable interest rate which means it is difficult to determine exactly how much interest you will end up paying.

Which type of line of credit is best for me?

There are multiple types of lines of credit (LOCs). A personal line of credit is just one type. Each type of LOC has its own set of pros and cons. Evaluating your situation along with the characteristics of each different type of LOC will help you determine which kind is best for you.

Personal lines of credit

If you have some unexpected personal expenses to cover in a short period of time, but you have no collateral (like a house or a car), a PLOC could be the best option for you. PLOCs are typically granted to individuals with good or excellent credit history since a lender is taking your word that you will pay back what you borrow with this type of LOC.

Business lines of credit

A business line of credit and a personal line of credit are functionally the same — you’ll receive a credit limit, which you can draw up to and pay back as needed. However, business lines of credit may have higher limits and are designed specifically for businesses. A business may use a line of credit for equipment purchases, short-term cash flow issues and more.

Home equity lines of credit (HELOCs)

A home equity line of credit uses the equity you’ve built up in your home to determine your borrowing amount. Unlike personal lines of credit, these loans are secured — meaning your home is used as collateral for the loan, and failing to repay the loan could put your home at risk of foreclosure. However, because you take on more risk with this type of borrowing, interest rates are often much lower.

How to find the best personal line of credit

You will need two primary things if you want to get a personal line of credit: a good credit score and solid credit history.

“You want to have the best credit you can have,” Dave Sullivan, credit expert with People Driven Credit Union, says. “If you have any revolving lines of credit, it’s best to pay those down as low as you can prior to applying, and make sure that info has been reported to the credit bureaus.”

And although a personal line of credit may have higher rates than something like a home equity line of credit (HELOC), the interest rates on PLOCs are usually much lower than those of a credit card cash advance or payday loan.

Check with multiple lenders to see who will give you the best terms. You will want to consider interest rates, repayment terms and the length of the draw period.

The application process for a PLOC is much the same as applying for any loan, and it can often be completed online. Once you’ve decided on a lender and the credit limit you’re seeking, you’ll need to provide information such as your name, Social Security number and employment and income details.

The bottom line

A personal line of credit can be a great method of borrowing, especially for people with great credit histories. It offers flexible terms and can help with cash flow or big expenses.

Before agreeing to any new borrowing, assess your needs and make sure that you have room in your budget for a new monthly payment. If you’re ready to apply, shop around with a few lenders to compare rates.

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Written by
Dan Miller
Points and Miles Expert Contributor
Dan Miller is a contributing writer for Bankrate. Dan writes about loans, home equity and debt management.
Edited by
Associate loans editor