Personal lines of credit are flexible and convenient for borrowers who need funds but want to avoid taking out a traditional loan. With a personal line of credit, borrowers can borrow what they need when they need it and start accruing interest only on the amount borrowed.
While there are advantages to this type of loan, there are also potential drawbacks that borrowers should consider. In this blog post, we will explore the pros and cons as well as alternatives to consider and answer some common questions about this type of loan.
What Is A Personal Line Of Credit?
A personal line of credit is a revolving credit extended to an individual borrower by a lender, such as a bank or credit union. This type of personal loan allows the borrower to draw funds up to a pre-approved limit, as and when needed, for any purpose, such as emergency expenses or planned purchases.
The borrower is charged interest on only the money they have withdrawn rather than the total limit, making it a flexible and convenient way to borrow money. Unlike traditional loans, they do not have a set repayment schedule, and borrowers can repay the borrowed amount at their own pace as long as they make the minimum monthly payments.
What Can I Use A Personal Line Of Credit For?
Users can use their personal lines of credit for various purposes, including unexpected expenses or planned purchases. One of the most significant advantages of personal lines of credit is the flexibility it provides to a borrower regarding how they use the funds.
For instance, a user can use it to cover medical bills, home repairs, car maintenance, or other unexpected expenses that may arise. They can also use it to finance a large purchase, like a car, furniture, or electronics. Additionally, it can consolidate high-interest debts, such as credit card balances, into a single, more manageable monthly payment.
Types Of Lines Of Credit
There are different types of personal lines of credit; unsecured and secured. Unsecured personal lines do not require collateral, while secured personal lines of credit require collateral, such as a savings account or home equity. Some lenders or credit unions may offer a fixed-rate loan, meaning the interest rate remains constant throughout the borrowing period.
In contrast, others may provide a variable-rate loan, meaning the interest rate can fluctuate over time. Banks may also have a demand line that works similarly but allows a borrower to call for (demand) repayment at any time. Check out the various options below:
Personal Lines Of Credit
This is a flexible borrowing option that can be used for various purposes. It is ideal for those who need money but want to avoid committing to a fixed term or interest rate. They can be secured or unsecured loans and have a variable or fixed interest rate.
Borrowers only pay interest on the amount they borrow, making it a cost-effective option. They can be a good choice for those who need to finance emergency expenses or ongoing projects that require funds over time.
Unsecured Personal Line Of Credit
It is a personal line that does not require any collateral. This means that the borrower is not required to pledge any assets, whether it’s a house or car, to secure the loan. An unsecured line typically has higher interest rates than its secured counterpart, and the amount that can be borrowed is often lower.
However, they are a good option for those who do not want to put their assets at risk.
Secured Line Of Credit
This is a revolving line that requires collateral, such as a savings account or home equity. This means that the borrower must pledge an asset to secure the loan. A secured line of credit typically has lower interest rates than unsecured ones.
Likewise, the amount that can be borrowed is often higher. They are a good option for those who have collateral to pledge and want to benefit from lower interest.
Business Lines Of Credit
It is a financing lump sum available to businesses. It is a type of credit revolving that allows companies to draw funds up to a preapproved limit as and when needed.
They can be unsecured or secured and have a variable or fixed interest. They are a good option for businesses that need to finance short-term projects, purchase inventory, or manage cash flow.
Home Equity Lines Of Credit (HELOCs)
This is a popular loan option backed by the equity in a borrower’s home. It allows homeowners to borrow up to a pre-approved limit, using their home as collateral.
They typically have lower credit when you pay interest rates than unsecured alternatives. They can be a good option for those who need to borrow a significant amount of money.
Read Also: Personal Loan Vs Home Equity Loan: Which One to Choose?
How to Get a Personal Line Of Credit?
A personal line of credit can help manage unexpected expenses or planned purchases. By following these steps, you can obtain one that suits your needs and financial situation:
Step 1: Determine if you meet the credit eligibility criteria
Before applying, try to meet the lender’s eligibility criteria, e.g. age, income, and good credit score. Check the lender’s website or contact their bank customers’ support team to learn more.
Step 2: Shop around for lenders
Research various online lenders and compare their terms and interest. Check if they offer secured or unsecured lines of options and if they have any fees, such as annual or monthly maintenance fees.
Step 3: Gather the necessary documents
Lenders typically require proof of income, checking account, employment, and identification. Ensure you have these documents ready before applying.
Step 4: Submit your application
Once you’ve found a lending institution that suits your needs, submit your application online, over the phone, or in person. Before signing the agreement, provide accurate information and read the terms and conditions carefully.
Step 5: Wait for credit approval
The lender will review your application and check for a solid credit history to determine your eligibility. You will receive a credit limit, variable interest rate, repayment terms and can withdraw funds if approved.
Can I Get a Personal Line Of Credit With Bad Credit?
Getting this type of personal loan with a bad financial reputation can be challenging, but it’s possible. Here are some steps to follow:
Step 1: Check your score
Before applying, check your score at the credit bureaus to determine where you stand. If your score is very low, getting approved may take time. However, some lenders or credit unions specialize in credit work with individuals with bad scores.
Step 2: Check several borrowers
Research various lenders that provide personal lines of credit for your score range. Check their eligibility criteria, fixed interest rates, credit limit, annual fee, etc., to determine which lender offers the best deal for you.
Step 3: Consider a secured loan
Secured alternatives will require collateral to secure the loan. However, it can make a great option for those with a bad score, as it reduces the risk for the lender
Step 4: Provide additional documentation
To improve your approval chances, collate additional documentation, such as proof of income, employment, and a co-signer with good credit. Difficulties you may face when getting a personal loan with bad score include higher interest rates, lower loan limits, and stricter repayment terms once the draw period ends. Additionally, you may face higher fees and a more lengthy application process for your credit personal lines.
Pros And Cons Of A Personal Line Of Credit
A personal line of credit tends to offer several advantages over others, e.g. auto loans, HELOC and personal loans, including flexibility, accessibility, and lesser credit interest rates.
However, there are also some potential disadvantages that borrowers should consider before applying. Check them out below:
Pros
- They allow borrowers to borrow what they need when they need it.
- They are often easier to obtain than other loans like personal loan because they do not require collateral.
- Usually have lower amounts when you pay interest rates than credit cards, making them a more affordable option for short-term borrowing.
- Borrowers can typically access funds online or through a mobile app, making it a convenient option.
- It can help borrowers improve their scores by establishing a positive payment history and reducing CUR.
- It does not require collateral, making it a lower-risk option for borrowers who do not have assets to pledge.
- Credit personal lines can be a good option for overdraft protection.
Cons
- This credit line comes with variable interest rates, meaning the rate can change over time before you start paying interest and therefore make repayment more difficult after the draw period.
- It can be tempting to borrow more than needed, leading to over-borrowing money and higher interest charges.
- Failing to make payments on time can result in penalties and additional interest charges, which can increase the cost of borrowing and damage credit scores.
Personal Loans VS Personal Line Of Credit
For their similarities, personal loans and personal lines of credit are forms of unsecured debt and provide access to funds for various personal expenses. Likewise, they might both require a credit check and approval process.
Regarding their differences, a personal loan gives you a lump sum of money upfront, while personal credit lines offer access to a set amount of funds that can be drawn upon as needed. Personal loans have a fixed rate and monthly payments, while others typically have variable interest rates and flexible minimum monthly payment terms.
Personal loans typically have fixed repayment periods, while their counterpart has no fixed repayment period after the draw period, as long as you make minimum payments. Personal loans are best for one-time expenses, unlike personal lines of credit, which are better for ongoing expenses or emergencies.
| Interest Rates | Repayment | Funds | Term Length | Credit Check | |
| Personal Loan | Fixed | Fixed | Lump sum | 1 to 7 years | Usually required |
| Personal Lines of Credit | Variable | Flexible | Usually as needed | Not set | Usually required |
Read Also: Personal Line of Credit vs Personal Loan
Alternatives To Personal Lines Of Credit
While personal credit lines can be a helpful financial tool, alternative options may better suit your needs. These alternatives include personal loans, home equity, and business lines of credit.
Each option has unique features, advantages, and disadvantages, making it essential to research and compare them to determine the best fit for your financial situation.
Personal Loan
A personal loan is a lump sum borrowed from a bank branch, credit union, or other financial institution. The loan is paid back in fixed monthly payments over a set period, typically two to five years.
Users should choose a personal loan if they need to borrow more money upfront for a specific purpose, such as a home renovation or to pay off higher-interest debt. Pros include a fixed rate, predictable monthly payments, and a set repayment period. Cons include a potential annual fee and interest rates that may be higher than other options.
HELOC
A home equity line of credit (HELOC) is a type of secured lines that allows homeowners to borrow against the equity in their home. A HELOC provides access to a set amount of funds that can be drawn upon as needed. Users should choose a HELOC if they have a significant amount of equity in their home and want to borrow at a lower interest rate.
It also often supports balloon payments since this is common in real estate mortgages. Pros include lower interest rates, flexible repayment terms after the draw period, and potential tax benefits. Cons include the risk of foreclosure if payments are not made and the potential for fees for its closed-end credit transaction.
Credit Card
Credit cards are revolving credit lines that can be used for purchases or cash advances instead of personal lines of credit. Users should select this over a personal line of credit if they need to make smaller purchases or have an emergency expense that they can pay off within the grace period to avoid interest charges.
Pros include convenience, rewards programs, and potential 0% APR promotional offers. Cons include high-interest rates, possible fees, and the risk of overspending and accruing high debt levels.
Conclusion
A personal line of credit can be a valuable financial tool for those who need access to funds on an as-needed basis. However, borrowers should consider the potential risks and drawbacks before applying for this type of loan.
It is essential to clearly understand the terms and conditions of the loan, like interest rates, fees, and repayment requirements after the draw period. By doing so, borrowers can make informed decisions about whether a personal line of credit is the right choice for their financial needs.
Sources Used in Research for the Article:
- What is a Personal Line of Credit, Consumer Financial Protection Bureau
https://www.consumerfinance.gov/ask-cfpb/what-is-a-personal-line-of-credit-en-901/ - What Should I Know About HELOC, Consumer Financial Protection Bureau https://files.consumerfinance.gov/f/documents/cfpb_heloc-brochure_print.pdf
- What happens if I do not pay back my Personal Line of Credit, Consumer Financial Protection Bureau
https://www.consumerfinance.gov/ask-cfpb/what-happens-if-i-do-not-pay-back-my-personal-line-of-credit-en-913/