What Is a Personal Line of Credit: Pros, Cons, and When to Use It
Many of us are constantly searching for loan options that enable us to buy assets and improve our fortune-growing abilities without jeopardizing our long-term financial health.
And while many consumers prefer traditional fixed bank loans or simply racking up high-interest credit card debt, few are willing to explore the lesser-known personal line of credit.
In our guide, we’ll walk you through the basics and cover all of the requirements as well as some of the risks associated with this loan option. We’ll also tell you where you can find the best deals on the market.
Personal Lines of Credit Explained
A personal line of credit (PLOC) is a revolving loan that allows you to borrow up to a certain limit, pay it back, and borrow again. Unlike a standard personal loan, you only pay interest on the amount you actually spend, not the entire credit limit.
Most PLOCs feature variable interest rates, meaning your monthly payment can fluctuate based on the Federal Prime Rate. While they are often used for debt consolidation or home repairs, they are increasingly popular as a flexible emergency fund because you don't owe anything until you draw funds.
Types of Lines of Credit
These are the different types of line of credit loans:
- Unsecured Personal Line of Credit: The most common PLOC. It requires no collateral but demands a higher credit score (typically 700+) and carries higher interest rates than secured options.
- Home Equity Line of Credit (HELOC): A line of credit secured by your home’s equity. Because your home is collateral, these usually offer the lowest interest rates on the market, but you risk foreclosure if you default.
- Securities-Backed Line of Credit (SBLOC): A specialized LOC where your investment portfolio (stocks/bonds) serves as collateral.
- Business Line of Credit: Designed for business expenses; these often require at least six months to two years of business revenue history to qualify.
How Personal Lines of Credit Work
We’ve established that a personal line of credit grants customers access to unsecured funds, which can be borrowed, repaid, and then borrowed again, essentially making it a revolving line of credit.
To open a personal line of credit, you’ll need a credit history free of defaults, a reliable source of income, and a credit score of 700 or higher for the best rates.
If you have a lower score, there are some emergency loans for bad credit you can consider instead.
In addition to these requirements, having savings can help, and even though you can qualify for personal lines of credit without collateral, having stocks or CDs helps.
You should also keep your debt-to-income ratio below 35–40%.
Pros
- Interest Efficiency: You only pay for what you use. If you have a $10,000 limit but use $0, you pay $0 in interest.
- Lower Rates than Cards: PLOCs typically offer lower APRs than unsecured credit cards.
- Flexible Repayment: Most offer lower minimum payments during the draw period, often interest-only options.
Cons
- Variable Rates: Your interest rate can rise unexpectedly if the central bank raises rates.
- Maintenance Fees: Some lenders charge annual fees or "unused line" fees if you don't draw money within a certain timeframe.
- Scarcity: Many large national banks have phased out PLOCs, making them more commonly found at local credit unions or online lenders.
It’s important to know what you’re getting into when taking out a personal line of credit. Understanding your obligations will also help you decide whether this is the ideal solution for your financial situation or if you should opt for alternatives such as personal loans or HELOCs.
Personal Lines of Credit vs. HELOC
Unlike HELOCs, personal lines of credit aren’t secured against your assets. That’s because the former option allows you to pull equity out of your home for loan financing. This introduces collateral, and now that the credit facility has become a collateralized loan, interest rates will typically be lower than with a personal line of credit.
Personal Line of Credit vs. Personal Loans
The biggest difference between a personal line of credit and a personal loan is that the latter is a lump-sum payment and a closed-end transaction. The lender issues the funds and expects repayment based on an agreed timetable.
How to Qualify and Apply For a Line of Credit
The qualifying process for a personal line of credit is quite simple.
Once you have chosen a lender willing to finance the personal line of credit and reach a mutually beneficial financial agreement, you’ll be asked for information regarding your current financial picture.
In addition to your credit score, required documentation may include the following:
- Employment history (last 2 years)
- Recent tax returns or W-2 forms
- Bank statements
- Verification of other debt obligations
- Proof of income
Because PLOCs are becoming a niche product, check with your local credit union first. They are currently the most likely institutions to offer competitive rates and lower fee structures for personal lines of credit,
For years, the clients I worked for were banks. That gave me an insider’s view of how banks and other institutions create financial products and services. Then I entered the world of journalism. Fortunly is the result of our fantastic team’s hard work. I use the knowledge I acquired as a bank copywriter to create valuable content that will help you make the best possible financial decisions.
