What is a personal line of credit? Pros & Cons Explained Simply
Do you need fast credit to cover an emergency or other type of expense?
Depending on your credit, you may have many options for short or long-term loans to cover your needs.
One option that may be available to you is a personal line of credit.
In this short guide, you’ll learn the meaning of a personal line of credit. Then, you’ll learn how personal lines of credit work and some of the pros and cons of opening them.
Finally, you’ll learn how you can find out if you qualify.
Here is how it works
A personal line of credit (PLOC) is a set amount of revolving credit. These lines are often made available to you by your financial institution (bank or credit union).
Once you have access to the line of credit, you can withdraw funds from it at will until you hit the limit.
How does a personal line of credit work?
A PLOC works by providing you with on-demand, revolving credit. Revolving credit describes situations where the credit refreshes after any debts are paid off.
You aren’t required to withdraw the entire amount. In fact, you typically won’t be required to make use of the account at all.
Interest will begin to accrue as soon as you have made a withdrawal. Your interest payments will depend on rates and how much credit you have withdrawn when interest is calculated. Credit lines may also charge monthly maintenance fees while the credit is withdrawn.
While the balances work somewhat like credit cards, PLOCs differ in some key ways. For one, they are accessed in different ways. PLOCs rarely have cards you can use for withdrawals. In most cases, you will need to manage these lines of credit in person or through your online portal for your financial institution.
Pros and Cons of a personal line of credit
A PLOC can offer you some financial flexibility. However, there are some drawbacks you need to understand. The best way to consider whether a PLOC is worthwhile to you is to compare the pros and the cons.
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- Fast access: You can quickly and constantly access your funds until the debt limit is reached. You are also usually able to do so online.
- Lower interest rates (compared to other loans): Personal lines of credit often have competitive interest rates compared to credit cards, payday loans, or other personal loans.
Unsecured and uncomplicated: A personal line of credit doesn’t require collateral. Your contract may stipulate that your financial institution can withdraw balances from your debit accounts to cover missed payments.
- No restrictions on use: You do not need to fill out any paperwork or give any reason that you withdrew from your credit.
- Flexible repayment options: Like a credit card, these loans can be repaid by making minimum payments until the debt is exhausted. However, you are also free to pay off the complete balance at any time.
- The interest isn’t tax-deductible: You may not deduct interest paid to these loans on your taxes. Unlike some loans (mortgages, for example), the interest for PLOCs is non-deductible.
- Annual/monthly maintenance fees: Your financial institution may require you to pay monthly fees for every month that the credit line is in use. These fees can add up significantly.
- Higher interest rates than fixed-rate loans: You will often pay higher interest rates for lines of credit than you will for secured loans such as mortgages.
- Variable interest rate: Some lines of credit may have a variable interest rate. You could end up paying a higher interest rate than the one in place when you borrowed against the line.
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How do I qualify for a personal line of credit?
You can qualify for a personal line of credit by speaking to a representative from your bank or credit union. Not everyone is approved for personal credit lines. Your bank may require that you have a history of banking with them.
Other standard credit scores may also apply. If you are being rejected as a result of credit, completing the following steps may help you:
Make sure you have an established payment history
You may be considered a higher risk for lending if you do not have an established payment history. Signing up for prepaid credit cards or small payment plans can help you develop a payment history. If you do not have a history of making payments, you may need to make payments for at least six months before you can qualify for personal lines of credit.
Take care of your credit score
Your credit score will be considered during most credit applications. If you do not have an established credit score, you may be rejected for a personal line of credit.
Developing your credit score is a long-term project. Start by making payments on time and avoiding problems such as missed payments or defaults. Once you have a personal line of credit, it may help you further develop your credit.
Monitor your financial condition
Banks may have access to other financial information that they use to assess your eligibility. Consider all of the following possibilities if you have been rejected:
- High debt-to-income ratio
- Low cash on hand
- Low net worth
To become more likely to be approved, you may need to increase your income and savings.
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Are you ready for a personal line of credit?
A personal line of credit can be a great financial resource. Now, you understand what it is, how it works, and some of the pros and cons that apply. You also know what it takes to qualify for a line of credit and some factors you need to track.
Use what you’ve learned to decide whether a personal line of credit is practical or possible for you.
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