What Is a Personal Line of Credit?

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A personal line of credit is a type of bank loan that allows you to use only what you need, and pay interest on only what you use. The interest rates vary based on the balance, but they may be lower than other financing options like credit cards. A personal line of credit encourages you to avoid spending more than you need, which may make it easier for you to stay out of debt.

Personal lines of credit are typically used for things that will take some time, where you can’t be certain exactly how much you’ll need. They useful for people who have unexpected expenses with uncertain totals, or for workers with variable income. Personal lines of credit may be a good option if you’re considering a home improvement project, if you want overdraft protection on your checking account, or you have irregular income and want an extra measure of protection. They’re designed to be a bit more flexible than traditional loans, but this freedom does come with some drawbacks. A personal line of credit may be harder to obtain without an excellent credit score, and the interest rates may not be the lowest on the market compared to other forms of credit.

At some point or another, you may need a little bit of help with your finances, so keep reading to learn if a personal line of credit may be right for you.

How Does a Personal Line of Credit Work?

A personal line of credit is similar to a credit card, since you are approved for a certain credit limit but still get to decide how much of that limit you spend. However, personal lines of credit typically offer much higher limits than credit cards, allowing you to use them to tackle projects like home renovations or school expenses. They typically range in amount from $1,500 to $100,000, though higher loans can be obtained.

Personal lines of credit function in two phases: the draw phase and the repayment phase. The draw period is when you use your money, which can occur for years at a time. The repayment phase is when you begin paying down the balance on your account. However, your personal line of credit may be structured more like a credit card, where your repayment begins immediately. This means that you would be required to pay back a portion of the borrowed amount every month, similar to a credit card payment.

How to Qualify

To qualify for a personal line of credit, some experts recommend having a good credit score. Getting approved for a personal line of credit will depend on several factors, but you may want to consider other types of personal lines of credit if your credit score isn’t good. Home equity lines of credit may be more accessible to homeowners with less ideal qualifications.

Types of Lines of Credit

There are two main types of lines of credit: secured and unsecured. Having a secured personal line of credit means that your credit is backed by some form of equity. This includes your car, home, or investments. These assets are collateral in case you don’t pay the loan back in its entirety. Because having collateral decreases the lender’s risk in loaning to you, interest rates may be lower for secured lines of credit.

Home equity lines of credit, also known as HELOCs, are credit lines that allow you to borrow on your home’s equity. To qualify, you must not owe more on the home than it is worth.

Interest Rates

Interest rates for personal lines of credit are usually somewhere around 9.24 percent and 17.99 percent. This is not significantly different than most credit cards which hover around 16.71 percent; however, it’s possible to open a personal line of credit at a better rate than a credit card. It’s important to do your research or talk to a financial advisor before committing to any loan option.

Personal line of Credit vs. Personal Loan

Personal lines of credit and personal loans may both serve to provide you with extra cash, but they have different benefits and drawbacks that you should be aware of before you choose which option is best for you.

First, personal lines of credit are a different type of credit than personal loans. There are three types of credit that get reported to major credit bureaus, and having a diversity of credit types may be beneficial to your credit score. A personal line of credit is a form of revolving credit, meaning that it does not have a fixed number of payments. A personal loan is an installment type of credit, meaning that it has a set length and terms, with a predetermined number of payments required.

The way you collect the funds for a personal line of credit and a personal loan differ as well. Personal lines of credit allow you to withdraw any number of times you wish, whereas a personal loan only disburses its funds once. This may allow you to be more mindful of spending only what you need with your personal line of credit.

However, personal lines of credit may have slightly higher interest rates than personal loans, which vary and go up across the life of the loan. This is because while both personal lines of credit and personal loan rates are affected by your credit score and history, but because personal lines of credit have a more flexible repayment, they pose a slightly greater risk for lenders. In addition, you may have more difficulty securing a good rate for a personal line of credit if your credit score is less than excellent. That’s why some may opt for a secured line of credit, or a personal loan.

There’s a lot to consider when comparing personal lines of credit and personal loans, so here is a simple chart summarizing their differences for your easy reference:

Two Things to Consider Before Opening a Personal Line of Credit

A personal line of credit is like any other form of debt in that you should fully evaluate your needs against the pros and cons of opening one. If you’re uncertain about whether or not a personal line of credit is right for you, talk to a financial advisor before making any major decisions. For now, here are some things to consider before you open a personal line of credit.

Financial Stability. Like many types of debt, you should feel confident that you will be in a position to repay the debt. A personal line of credit is not free money, and if you need more money than you will feasibly be able to repay, there may be a deeper issue with your finances you need to solve first.

Necessity. Because personal lines of credit are designed to be ideal for ongoing and undefined expenses, it’s important to consider what you will be using the money for. Personal lines of credit may be a good option for people starting a business and are unsure of how much they will need. However, if you only need a loan to cover something more concrete in scope and time like a wedding or education expenses, you may find that other options offer better benefits for your money.

Personal lines of credit can be a great way to ensure you only go into debt for the money you need. However, it is important to consider your personal funding needs before you apply for one. While they offer flexibility and high credit limits, they often require an excellent credit score and may not offer the most competitive interest rates. It’s important to do your research or talk to your advisor to ensure you’re making the best choice for your financial needs.

 

Sources:

SantanderBank | The SimpleDollar | Debt.org | StudentLoanHero | TheBalance | ValuePenguin | BankofAmerica | Bankrate | ValuePenguin 

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