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.

What Is a Personal Line of Credit?

A personal line of credit or PLOC is an agreement between two parties, usually a financial institution and a borrower, which defines the amount of money the borrower can access at any given time.

There are different types of repayment structures and interest expenses. Depending on the lender and individual circumstances, some borrowers may be charged application and maintenance fees for these lines of credit.

Many consumers use a personal line of credit to expand businesses, consolidate or refinance existing debt, pay medical bills, or renovate their homes. These loans aren’t typically intended to be used for one-time purchases. In some ways, a PLOC is a cross between a credit card and a personal loan.

Types of Lines of Credit

These are the different types of line of credit loans:

Unsecured LOCs vs. Secured LOCs

The most basic distinction between these two is that secured LOCs involve the use of collateral as a guarantee, while unsecured ones don’t. Ultimately, it’s the lender that decides whether you are eligible for an unsecured personal line of credit or a secured one.

The latter is easier to get because the loan is secured against your assets, while the unsecured option requires a good credit score. 

Most lenders are more comfortable with handing out secured loans. The collateral put down by the borrower offers a means to recoup the advanced funds in the event of a borrower defaulting. There are many reasons for nonpayment, from financial difficulties to even the death of a borrower, but all result in losses for lenders. 

Secured lines of credit are also advantageous for borrowers. In addition to the larger credit limits, they don’t have to deal with the high annual percentage rate or APR that comes with an unsecured line of credit.

In addition to the high credit score requirement for borrowers, unsecured loans also pose a high risk for lenders. As such, financial institutions work to minimize their exposure by limiting the amount of funds that can be borrowed and by charging higher interest rates.

Revolving vs. Non-Revolving Lines of Credit

Revolving lines of credit are arrangements where borrowers get access to an account with a specific credit limit that they can use and reuse. The funds are repeatedly made available to the borrower after payments are made to the revolving credit account.       

It’s important not to confuse these revolving accounts with mortgages or auto loans. With those installment loans, the borrowed amount of money is repaid in equal monthly installments. Once you pay off an installment loan, you cannot access the funds again unless you apply for a new loan facility.

On the other hand, a non-revolving line of credit establishes a credit limit, and funds can be borrowed for any reason. But there is one major difference. The credit pool does not replenish after the loan has been repaid. Once the loan is repaid, the account is permanently closed.

Aside from the personal line of credit, there are a few other LOCs:

Home Equity Line of Credit (HELOC)

This LOC is secured by the market value of the home minus the amount owed, which is used to determine the size of the line of credit.

Demand Line of Credit

This is either a secured or unsecured line of credit loan that enables customers to borrow funds on an on-demand basis. Meanwhile, the lender can require the amount borrowed to be repaid at any time. This can include interest plus principal or interest-only, depending on the terms of the LOC. The borrower can spend up to the credit limit at any time.

Securities-Backed Line of Credit (SBLOC)

This is a type of LOC in which collateral is provided by the securities in a brokerage account.

Business Line of Credit

This is a revolving loan with a fixed amount of capital, which is generally designed for short-term business needs. It’s a credit limit based on the market value, profitability, and risk taken on by the business. It can be secured or unsecured.

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 670 or higher. 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.   

Borrowers apply for personal lines of credit for a variety of different reasons, including weddings, travel and entertainment, emergencies, and overdraft protection.

Great as it sounds, a PLOC has both advantages and disadvantages.

Pros

• Access to funds: Once you’ve been approved for any credit amount, you can take out as much as you want, whenever you want, up to the credit limit.
• Strategic usability: Opening a line of credit enables you to adopt a strategic approach to dealing with finances. Suppose you have a $15,000 student loan and a $10,000 auto loan. With a PLOC, you can take out $25,000 in credit and pay these off at once. The big advantage here is that you can end up with a lower interest rate.
• Flexible lending: Based on your payments, the lender may offer you repeated access to the line of credit. This is referred to as an open-end credit transaction.

Cons

• The risk of unsecured loans: Personal lines of credit are unsecured loans because they do not involve collateral. This translates into high interest rates because the lender assumes all the risks.
• High credit score required: Interest rates aren’t the only thing you have to worry about. Due to the risk assumed by the lender, getting a PLOC requires a good credit score. Some lenders may accept 670, but others prefer scores of over 700.

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 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
• Your investment portfolio
• Bank statements
• Statement indicating what the credit line is intended for
• Proof of income

How to Apply For a Personal Line of Credit

Applying for a personal line of credit is a straightforward process that you can generally complete online. Once you decide on a lender, as well as the credit limit your financial condition requires, you’ll have to provide personal information, including your name, social security number, employment details, and income.

Many lenders will give you access to the funds within two business days once the application has been approved.