What Is a Personal Line of Credit and How It Works
A personal line of credit (PLOC) offers flexible access to funds that you can borrow, repay, and reuse as needed. This guide explains what a PLOC is, how it works, its requirements, fees, and the pros and cons to help you decide if it suits your financial needs.
Personal Line of Credit (PLOC) is a facility of flexible credit extended to a set amount of money, where the borrower can draw against, repay, and borrow over and over again. It was developed to be more flexible than a loan since many people have different needs for money. Ideal for managing unexpected expenses or cash flow, it's most beneficial for individuals with stable incomes and good credit. However, it should be used responsibly, as mismanagement can quickly lead to accumulating debt.
What Is a Personal Line of Credit?
A personal line of credit is a flexible financial product that provides access to a set amount of money, which you can borrow and repay as needed. Unlike a traditional loan, you only pay interest on the amount you borrow, not the total credit limit. PLOCs are useful for covering recurring needs, like business expenses or purchases, without the need to apply for new loans each time.
PLOCs can be used for various purposes, such as home improvements, medical bills, debt repayment, or business funding. However, they carry risks, including variable interest rates, fees, and the temptation to overspend.
Providers like banks, credit unions, and online lenders typically require a credit check and approval based on your financial situation, with terms varying by lender.
Personal Line of Credit Requirements
Minimum Credit Score. The minimum credit score to avail of a personal line of credit ranges from 600 to 700, depending on the lender. The higher the credit score, the better the chances of getting approved and, probably, with better terms, such as lower interest rates.
Income Requirements. Lenders generally require proof of a stable income to assess your ability to repay the credit line. This can include salary, self-employment income, or other sources of revenue. The required income amount varies by lender.
Debt-to-Income Ratio. The proportion of one's income used toward paying off existing debts each month. This is what determines to the lender your capacity for more debt; the lower the ratio, the better the chances.
Collateral (for Secured PLOC). For secured personal lines of credit, lenders may require collateral, such as property, savings, or investments, to secure the line. This reduces the lender's risk and may allow for a higher credit limit.
Credit History. Your credit history comprises your previous debts, payment history, and current usage of credit. A good credit history with timely payments enhances your chances of approval.
Employment Status. Most lenders will want you to be employed or at least earn a regular income since this indicates stability in terms of finances. The self-employed, on the other hand, may have to present added requirements.
Minimum Opening Limit. In opening a personal line of credit, lenders typically set a minimum amount as required by their policy. This amount varies and one needs to be sure it meets the financial requirement one seeks.
Bank Account. Some lenders will want you to have an account with them, which should be active before they approve a line of credit. This way, it is easy to carry out payments and transactions.
Age Requirement. The applicant should be 18 years or older; however, some states may set a higher minimum age than 18 for credit applicants.
Citizenship/Residency Status. Lenders generally need applicants to either be U.S. citizens or permanent residents. Non-residents may have fewer options for access to personal lines of credit, depending on the lender's terms.
Personal Line of Credit Fees
Annual Fee. Some lenders charge an annual fee for maintaining a personal line of credit. This fee tends to be a fixed cost payable each year, regardless of usage.
Usage Fees. These are fees for accessing your funds, including draw fees, a percentage of the amount withdrawn; cash advance fees, if you draw out cash instead of making purchases; and over-limit fees, if you go over your credit limit.
Late and Returned Payment Fees. These are the fees charged for late or returned payments due to a lack of sufficient funds. They can be either a flat fee or a certain percentage of the missed or returned payment amount.
Interest Charges. This includes interest charged on the amount you borrow from your line of credit, generally at a variable rate and higher than that of other types of loans.
Inactive Account Fee. Some lenders charge a fee if you do not access your line of credit over a long period, usually over 12 months.
Origination Fee. Some lenders charge an origination fee when you open the line of credit. This is often a percentage of the credit limit and may be deducted from your available credit upon opening the line.
Payoff Fee. Some lenders may charge a fee if you pay off your line of credit early, especially in the case of secured credit lines or loans with particular terms.
How Personal Line of Credit Works
A line of credit provides you with a flexible way to borrow money, which you can use whenever you need it. Once your PLOC is approved, you are given a credit limit, and you can borrow any amount up to that limit.
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Borrowing and Repayment. You can borrow money from your credit line as needed. You only pay interest on the amount you borrow, not on the entire credit limit. For example, if your limit is $10,000, but you only borrow $3,000, interest is only charged on the $3,000, not the full $10,000. When you repay part of the borrowed amount, that money becomes available again to borrow.
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Paying Back. Repayment schedules vary. Some lines of credit only require you to pay interest during the draw period, and you pay back the principal later. Others may require you to pay both principal and interest, either monthly or quarterly. This flexibility makes a LOC a useful tool for managing cash flow and expenses over time.
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Credit Limit. Your credit limit depends on factors like your credit score, income, and financial history. This limit may change over time, especially if your financial situation improves. Some lenders may even offer automatic increases if you're using your LOC responsibly.
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Accessing Funds. Most lines of credit allow you to access funds through checks, a credit card, or a bank transfer. For example, you can withdraw money as you need it and pay it back on your schedule, as long as you stay within the credit limit.
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Costs. While lines of credit offer flexibility, they typically come with fees. There might be an annual fee, a one-time setup fee, or fees for drawing funds. Interest rates can also vary, with some LOCs having variable rates that change over time.
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Repayment Period. Once you’ve used the LOC, you enter the repayment phase. This period typically lasts a few years, during which you must pay back what you’ve borrowed, either in full or in installments, depending on your agreement with the lender.
Types of Personal Lines of Credit
Different types of lines of credit respond to different needs. Among them, the two main categories are unsecured and secured lines of credit. Unsecured lines of credit are not collateral-based, and your creditworthiness is the basis for approval. Secured PLOCs are those that require collateral, such as a home or car, and generally offer lower interest rates. A popular example of a secured LOC is the Home Equity Line of Credit, which uses the equity in your home for collateral.
Lines of credit can also be categorized into either revolving or non-revolving. Revolving PLOCs allow you to borrow, repay, and borrow again, much like how credit cards work. Non-revolving PLOCs are like regular loans, whereby when you borrow and pay it back, the line of credit is closed, and you will not have access to that credit anymore. These distinctions are important to consider in your choice of the best LOC for your financial situation.
Types of PLOC
Personal Line of Credit. A personal line of credit is a flexible loan option that allows the borrower to borrow money up to a set limit for various personal expenses such as emergencies, home improvements, or debt consolidation. It can be either secured or unsecured. Unsecured lines are based on your creditworthiness, while secured ones require collateral. Most personal lines of credit are revolving, meaning you can borrow, repay, and borrow again. Lenders typically require a good credit score and stable income for approval.
Home Equity Line of Credit (HELOC). A HELOC is a type of secured line of credit that uses the equity in your home as collateral. This lets you borrow against the equity of your house at often more favorable interest rates compared to unsecured PLOCs. It is a revolving line of credit, which means that one can borrow and repay multiple times. To be qualified, one needs home equity, a good credit score, and a stable income. Sometimes the lender considers a debt-to-income ratio, too.
Business Line of Credit. A business line of credit works similarly to a personal line of credit but is designed for business purposes, such as managing cash flow or covering operational costs. It can be secured or unsecured, with secured lines requiring collateral such as business assets. A business LOC is typically revolving, allowing you to access funds, repay, and borrow again. Lenders typically require a solid business credit history, financial statements, and proof of income to qualify.
Demand Line of Credit. In this type of line of credit, the lender can call in the full balance at any time without notice. It is normally unsecured and revolving, enabling you to borrow, payback, and then again borrow. Because of this flexibility and risk on the part of the lender, this credit line may carry a higher interest rate. This is normally extended to businesses and people with very good financials and creditworthiness.
Securities-Backed Line of Credit (SBLOC). This is an open line of credit using one's investment portfolio as security. Usually, an SBLOC is revolving; therefore, the borrowers are allowed to draw down and repay on demand. The total amount they could borrow will be predetermined based on their securities' value. Normally, lenders request that a specific level of assets be inside the portfolio, plus good credit, to consider offering an SBLOC.
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Pros and Cons
Pros
A PLOC allows you to borrow money when needed, giving you the ability to manage cash flow and unexpected expenses easily.
Interest is only charged on the amount you borrow, not the entire credit limit, making it more cost-efficient than traditional loans.
For revolving lines, you can borrow, repay, and borrow again, offering ongoing access to funds without reapplying.
Cons
The easy access to credit can lead to borrowing more than you can afford to repay, increasing financial strain.
Many PLOCs have variable interest rates, which can increase over time, making it harder to predict monthly payments.
Some PLOCs come with fees, such as maintenance or transaction fees, that can add up and increase the overall cost of borrowing.
Types of Repayment for a Personal Line of Credit
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Draw and Repayment Periods. The draw period is the period in which you are allowed to draw from your line of credit. When that draw period expires, the repayment period starts, and you need to repay the amount you drew. During the draw period, you may be required to pay interest only, while during the repayment period, both principal and interest are payable.
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Balloon Payments. A balloon payment is a very large, single payment due at the end of the loan term or repayment period. This usually happens when throughout the term, the borrower has been making interest-only payments, and the rest of the balance is repaid in one lump sum.
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Demand Line of Credit. Under this type of line of credit, the lender can demand the outstanding balance repayment at any time, often with very short notice. The terms are usually more flexible, but the risk is higher for borrowers because the lender can call in the loan at any time.
When a Personal Line of Credit Is Useful
A line of credit is useful for covering emergency expenses like medical bills, car repairs, or home maintenance, offering quick access to funds without the need for a full loan. It also supports short-term projects, enabling businesses to fund inventory purchases or take on projects without draining cash reserves. Additionally, it helps manage cash flow, particularly for individuals with irregular income or businesses with seasonal revenue, allowing for flexible borrowing and repayment.
When to Avoid Personal Lines of Credit
A line of credit is better for short-term needs, not long-term financing. For large purchases like real estate or equipment, term loans with fixed rates are more suitable. Using a line of credit to consolidate high-interest debt can be risky due to variable rates, while fixed loans offer more stability. Businesses with inconsistent revenue may struggle to manage a line of credit, as fluctuating income can lead to missed payments and higher interest, making more stable funding options a better choice.
Conclusion
FAQ
How long does a personal line of credit last?
A personal line of credit typically lasts for 3 to 5 years during the draw period. After this period, once you have repaid the balance in full, you will need to reapply for the credit line.
Does a line of credit affect your credit score?
Yes, a line of credit can positively and negatively impact your credit score. A hard inquiry on your credit report can temporarily lower your score while adding a new line can reduce the average age of your accounts. However, adding a revolving credit account does improve your credit mix. Your use of the credit line makes an impact on your credit utilization ratio, which may either raise or lower your score depending on your balance. Making on-time payments builds a positive payment history, which helps improve your score. Missed payments will lower your score.
Is it good to have a line of credit but not use it?
Yes, having a line of credit without using it does give one flexibility since you only pay on the interest of what you borrow. And if you don't use it, no interest accrues. However, there are usually fees for maintaining, inactivity, or even cancellation of an account. It's important to review the terms and conditions before signing to understand any potential costs.
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