Pros and cons of a personal line of credit: Here's what you should know

A personal line of credit can give you instant, ongoing funds for your goals, often with interest rates lower than credit cards. It’s a great option for whatever life throws your way, but there are some downsides.

Just like a credit card, a personal line of credit gives you access to funds immediately. And you only pay interest on the money you use. That’s super handy when you have a big project or bill with lots of unexpected costs or if you want to consolidate high-interest debt.

How does a personal line of credit work?

When you apply for a personal line of credit, a set amount of money is made available to you over a period of time, called the draw period. You choose when to draw out the money. And you only pay interest on the money you use. If you repay the funds during the draw period, it replenishes your balance.

What is a personal line of credit good for?

There are many uses for a personal line of credit. But, generally speaking, it’s best for situations where you have ongoing expenses and you may not know the full cost of the project, like a kitchen remodel, unexpected medical expenses or dental procedures, or financing a new car The interest rate for a personal line of credit is typically lower than a credit card and comes with higher credit limits so it’s a better choice for bigger expenses. It’s also a good option for paying off high-interest debt.

How is a personal line of credit different from a credit card?

Both a personal line of credit and a credit card provide the borrower with access to funds that can be used when they choose. But there are significant differences:

1.  The interest rate for a personal line of credit is usually lower than a credit card.
2. The credit limit on a personal line of credit is usually higher than on a credit card.
3. With a personal line of credit, interest begins the day you draw funds. Credit cards offer a grace period which allows you to pay off your balance each month without being charged interest.
4. A personal line of credit may come with withdrawal fees, whereas a credit card doesn’t.

Most credit cards offer rewards, including cash back or travel miles.

What are the pros and cons of a personal line of credit?

There are many factors to consider when thinking about a personal line of credit. Here are some:

Pros

• Interest payments: Unlike a traditional (term) loan, you only pay interest on the money that you use, rather than paying interest on the overall loan amount.
• Flexibility: A personal line of credit usually has a long draw period, often a few years. That means you can access the money any time you need it.
• Replenishing balance: When you pay back money within the draw period it becomes available again to borrow.
• A powerful financial tool: The money from a personal line of credit can be used for just about anything, so it can be a powerful way to pay down higher-interest debt.

Cons

• Interest rates: A personal line of credit may come with a higher interest rate than similar products like a term loan. (Though the rates are usually lower than a credit card.)
• Variable interest: Interest rates tend to be variable for a personal line of credit, though some banks offer fixed rates.
• Fees: Most personal lines of credit have associated fees like an annual or monthly maintenance fee and a transaction fee which is charged every time you draw money.
• Credit score: Because a personal line of credit is not usually backed by any collateral—it's unsecured—people with a low credit score may have difficulty qualifying or getting favorable rates.

Types of lines of credit

There are a few different types of credit lines available, including:

• Unsecured line of credit: This is the most common form. No collateral is required, instead the lender uses your credit score, credit history, and income and existing debt to determine qualification and terms.
• Secured line of credit: A secured line of credit is a loan based on collateral. A popular secured line of credit is a HELOC, or a home equity line of credit, where you borrow against the equity of your home and use your house as collateral.
• Business line of credit: A business line of credit works just like a personal line of credit but for business owners. They come with higher limits often capped at $100,000, though higher limits are available.

Frequently asked questions:

There are a few different types of credit lines available, including:

1. What do I need to apply for a personal line of credit? Typically, lenders will want you to have a credit (FICO) score of 680 or above. You’ll also need to provide your current debt and income, as well as your credit history. Finally, you’ll need to have a checking account with the lender with no history of recent overdrafts.
2. How can I access money from a personal line of credit? It’s very easy to access money with a personal line of credit. Many lenders provide borrowers with checks or a card linked to the line of credit that can be used to draw money as needed. You can also have the money deposited into your checking account.
3. How do I pay the money back? As the borrower you are responsible for making the minimum payments each month. But, depending on the terms of your loan, that could be interest-only or it could include principal and interest.
4. Is a personal line of credit right for me? A personal line of credit comes with a lot of flexibility, but just like any credit product you have to have a repayment plan in place. Missing payments or failing to repay the loan can hurt your credit score.

Personal lines of credit can be a flexible way to help you reach your goals – especially if you aren’t sure exactly when you might need the money. But they generally require that you have good credit.

Find out more about available credit lines and learn how to build and maintain a good credit score.