What is a personal line of credit?

Key points

• Like a credit card, a personal line of credit allows you to draw on a credit limit as needed—and you only pay interest on the amount you borrow.
• You can qualify for a personal line of credit thanks to your creditworthiness (unsecured) or collateral (secured).
• While sometimes useful, a personal line of credit often carries fees and can tempt you to overspend.
• Review your needs to determine whether you might be better off borrowing a personal loan versus a personal line of credit.

A personal line of credit (PLOC) is a form of revolving credit that lets you borrow up to a maximum amount of money out over a specific period.

“These credit lines allow you to access the available funds and repay them to return to your available balance,” says ShirleyAnn Robertson, a broker at Prudential Financial. “Think of it like a credit card: The bank gives you a limit, you charge the card and pay it off each month, so the available funds are replenished.”

How do personal lines of credit work?

Before you can get a personal line of credit, you’ll have to qualify.

“Borrowers need a reliable income, a credit score of usually 670 or better, and a credit history that doesn’t contain any defaults,” says Robertson. “Having collateral in the form of savings or retirement accounts can sometimes help with approval.”

Once you’ve been approved by a bank or credit union, you can start accessing that cash. The outstanding balance will be subject to interest charges. The interest rate for PLOCs can either be fixed (meaning they always stay the same) or variable (they change with the market). Either way, the initial rates are typically based on creditworthiness.

Another key aspect here is that you may have a minimum monthly payment, and you may pay a fee each time you access that cash. There are PLOCs that require you to ‘clear’ your balance every year, too, by paying it off for a fresh start the next year.

Again, PLOCs are only available for a set amount of time, so when that window closes, so does your access to the line of credit.

Example of personal line of credit repayment

Let’s say you have a $10,00 PLOC at your bank or credit union. If you leave it alone, you don’t have to pay any interest or fees. But if you were to take out a $1,000 loan from that line of credit, you may pay a withdrawal fee, depending on your terms, and you’d owe interest on the withdrawn amount.

If you got a fixed 10% APR, that would be your rate until the PLOC expires. So you’d owe $100 in interest if you left that balance for a year (excluding the minimum payment amounts). But if your PLOC has a variable rate, you’d have to check with the bank or credit union to see what your rate is at that time. (It could be higher or lower than your original rate, depending on the market.)

From there, you’d have to make at least the minimum monthly payment to avoid any late fees. And your available PLOC would decrease to $9,000 until you’ve repaid the full amount. Plus, once the draw period ends, you’d have to repay the entire borrowed amount.

Pros and cons of personal lines of credit

Personal lines of credits can be useful financial tools, but they’re not for everyone. Here are some of the main pros and cons:

Pros

• Access funds throughout the draw period, rather than just once.
• The limit goes back up to the maximum once you pay off what you’ve borrowed.
• Only pay for the money you use.

Cons

• Since it allows for multiple withdrawals, it’s possible to overspend.
• There may be fees to access funds, in addition to annual, maintenance and late fees.
• Potentially high interest rates for unsecured PLOCs.

“For many, the biggest con is that it may be difficult to obtain a personal line of credit if you do not fit all the requirements,” says Robertson. “And [PLOCs] may not be [right] for everyone. For those consolidating debt to lower their interest expense, it only helps if they don’t acquire new debt.”

For example, if you were to pay off a credit card balance with a PLOC but didn’t stop using that card, you might end up back at square one. But you should also consider what impact it could have on your credit.

“Like most debt, a personal line of credit directly impacts your credit score when payments are missed or late,” says Robertson. “It’s crucial to budget beforehand to guarantee that you are able to make each payment on time.”

Examples

Aside from PLOCs, there are a few common types of lines of credit (LOC), including:

• Home equity line of credit: This is a secured form of credit which lets you borrow against the equity you’ve built up in your home. The house is used as collateral.
• Business line of credit: This LOC typically functions as revolving credit and allows business owners to access cash for their businesses.
• Securities-backed line of credit: This lets you access the value of your investments without selling any of your securities. It uses said securities as collateral.

And there are also two primary categories that fall under the PLOC umbrella:

1. Secured: This means you have to put something up as collateral in order to access the PLOC funds. But if you stop making payments, you may lose that collateral.
2. Unsecured: These rely on credit, rather than collateral, to qualify. They typically have higher interest rates than secured lines of credit.

PLOC vs. personal loan: What are the differences?

While both PLOCs and personal loans let you borrow money for personal use, there are some significant differences between these two financial products.

For example, while you can borrow money from a PLOC over time, a personal loan is a one-off event. So you’d have to apply for a second personal loan (which would impact your credit) if you were to want additional money.

Also, personal loans often have fixed interest rates, which can be more predictable, while PLOCs can have variable rates.

Finally, personal loans charge interest on the full amount, while PLOC funds only incur interest on the outstanding balance. Either way, you’d pay interest, and potentially fees, to borrow money from a PLOC or personal loan.

Frequently asked questions (FAQs)