What is a personal line of credit?

A personal line of credit can function as a credit card with its own pros and cons to consider.  (iStock)

As the name suggests, personal lines of credit are mainly used for covering personal expenses like education costs, car repairs, or medical debts. If you’ve been thinking of taking out a line of credit to cover these costs, keep reading. We’ll explain what a line of credit is, the advantages and disadvantages of using one and how you can get one today.

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What is a personal line of credit?

Unlike a personal loan, where you’re given a lump sum of money that’s paid back in fixed, monthly installments, a personal line of credit functions more like a credit card. In this case, you’re given a set period of time - usually known as the “draw period” - where you can borrow money as needed, up to your credit limit.

HOW TO WIPE CREDIT CARD DEBT FAST

With a personal line of credit, interest only accrues on the money you borrow and, during the draw period, you usually only have to make payments on the interest. After your draw period is over, you then enter the “repayment period,” where you’ll be required to make payments on the entire amount of what you’ve borrowed.

Pros and cons of using a line of credit

Pros

  • Flexibility: You have the ability to borrow only as much as you need.
  • Revolving credit: If you pay down your balance, you can use the line of credit again to cover a different expense. 
  • Not tied to an asset: A personal line of credit is typically an unsecured loan, which means you don’t need to use collateral like your home or a savings account to take them out. 

Cons

  • High, variable interest rates: While the interest rate on a personal line of credit is typically lower than a credit card, it’s usually higher than with a traditional bank loan. Their interest rates are also variable, which can make your monthly payment unpredictable.
  • Fees: Many lines of credit come with fees, including an annual one.
  • Temptation to spend: Having a line of credit at your disposal can make it tempting to spend money and put yourself further in debt.

How to apply for a personal line of credit

The process to apply for a line of credit is pretty much the same as applying for any other loan. You apply through a bank or credit union for the credit limit that you’re seeking. It’s worth noting that banks that give personal loans like Bank of America or Wells Fargo more commonly offer these options than online lenders.

CREDIT CARD VS. PERSONAL LOAN: WHICH ONE IS A BETTER OPTION?

You need two things in order to apply for a line of credit:

Since personal loans are unsecured and the lender has less reassurance that they’ll be repaid, approval for these loans typically weighs heavily on your credit score. Your score will also impact the interest rate that you’re given. For best results, do all you can to get your credit into shape before applying.

Alternative lending options

  • Personal loan: Small personal loans are a good option if you know exactly how much you need to spend. They’re also preferable if you like the security of having set monthly payments.
  • Business line of credit: A business line of credit is similar in the way that it functions, but it’s used to cover business expenses.
  • Home equity line of credit (HELOC): With a HELOC, you borrow against the equity you have built up in your home. These lines of credit typically have lower interest rates.