What is a Personal Line of Credit & How Does it Work?

28 Jan 2021

A personal line of credit is an unsecured bank loan that you can use for any purpose, as needed. As it is unsecured, you will need a good credit score, typically credit score of 680 or higher, and have a decent history of repaying debts in a timely manner. The personal line of credit may be cheaper than a credit card advance and more flexible than a personal loan.

A personal line of credit may bail you out when you need to borrow money incrementally. It can be used for home renovation projects, for a great vacation, medical bills, big-ticket purchase, child’s fees. 

How did it work?

You get preapproval to borrow a certain amount from lenders, but unlike a loan, you don’t necessarily get the full amount immediately. You get variable access to cash instead of a lump-sum or single-purpose loan, as you need it, through electronic transfer and check.

The maximum amount you are eligible to borrow varies based on your creditworthiness and financial institution. While Citi's top credit limit is $25,000, SunTrust offers lines of up to $250,000 and at Wells Fargo, it ranges from $3,000 to $100,000. 

You are not necessarily required to disclose what you want the money for when you apply, but you could. However, it would depend on the financial institution and the amount being borrowed. 

You can get access to your personal line of credit via online transfer or check, and you will need to make monthly payment only for how much you owe. For example, at Wells Fargo, the minimum payment is $25 or 1 percent of the balance owed and the sum of all finance charges and fees. Wells Fargo charges a $25 annual fee, with zero cash advance or balance transfer fees. No interest is charged on the unused amount.

Qualification for a line of credit

A personal line of credit is unsecured in nature, it is usually offered to the customer with a strong credit qualification who not only has a good credit score but also is capable of repaying the line.

The better your credit score, the more likely you are to get a personal line of credit on good terms. Every lender lays down its own set of rules and standards and changes them rapidly based on competition and other factors. Paying interest on the borrowed balance, while the line is open for borrowing, makes it different from conventional lending, which is repaid in fixed installments.

Why you might need a line of credit

For people who have irregular income, uneven cash flow or work on commission, a personal line of credit can rescue them from cash flow issue. A personal line of credit is something that a borrower can access on a regular or irregular basis to resolve financial issues. A personal line of credit can be used to pay a tax bill.

Uses of a personal line of credit

A personal line of credit can be used for almost anything. The interest rate and flexible repayment options make a personal line of credit worth considering.

  • You can use a personal line of credit to execute the projects with funding challenges. For example, your daughter’s marriage and your home renovation may take place simultaneously.
  • If you have irregular income and the next paycheck is not coming for another month. In this case, drawing from a line of credit helps you pay your regular monthly bills.
  • Emergency situations like dates of tax bill, credit card bills coming with college fee for your child. You can consolidate your debts with a line of credit.
  • One can use a line of credit as collateral if they want to stimulate growth through marketing, advertising or participating in tradeshows.

Line of credit Vs a personal loan

Line of credit and a personal loan may seem similar but they are different from each other.

In a personal line of credit, you are allowed to borrow only the money you need. Interest rates for a personal line of credit are variable and generally lower than fixed loan rates. Your payments vary depending on the outstanding balance.

In a personal loan, on the other hand, you receive the lump-sum amount up front. If you know how much money you need at once, a personal loan may help you better than a personal line of credit. Personal loans have a fixed rate of interest over a fixed term, which helps a customer figure out precisely when his entire loan will be repaid. 

If you tend to spend extravagantly and can’t avoid borrowing more than you can reasonably repay, don’t take the line of credit.

Line of credit versus a credit card loan
Both credit card and personal line of credit offer you only the money need and when you need it. But credit card runs higher annual percentage rates (APRs) than lines of credit. Generally, APR on credit cards is at least 13 percent even for consumers with good credit. Someone with good credit can get a personal line of credit for less and often under 10 percent.

Advantage of a personal line of credit

  • You can avoid paying interest on unused money.
  • If you have irregular income or uneven cash flow, you can use the credit line to cover bills while waiting to get your paycheck.
  • Interest rates are likely to be lower than for a personal loan and credit card (it is advisable to check to be sure).
  • You can access the line as a source of emergency funds.
  • Real-time access to fund.
  • Overdraft protection on some accounts.

Drawbacks of a personal line of credit

  • It is a readily acceptable credit that can be risky if you tend to spend extravagantly.
  • Many have an annual fee, even if you don’t use the credit.
  • Hard to qualify with bad credit. You might not be eligible for a personal line of credit if your income or credit has suffered.

A personal line of credit can be a great financial assistance when it is used wisely. However, if you lack the discipline to handle it, you also run the risk of temptation to over-borrow. In that case, you should go for a personal loan. 

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