Personal Line of Credit: What Is It and How Does It Work?

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If you need to cover unexpected expenses, such as a medical emergency or a car repair, a personal line of credit might be a good option. A personal line of credit allows you to borrow a set amount of money whenever you need it.

Here’s a closer look at what a PLOC is, including how it works, the pros and cons and whether you need one.

What Is a Personal Line of Credit?

A personal line of credit is a revolving account that enables you to borrow money up to a specific limit over a set period. Like a credit card, a PLOC gives you the flexibility to borrow whenever you need without taking a full amount in one lump-sum payment. 

These lines of credit are typically unsecured, meaning you don’t need collateral to borrow money. However, lenders sometimes allow borrowers to deposit collateral to get more favorable terms, typically in the form of lower rates. 

Unlike secured credit cards, PLOCs generally have higher rates. For this reason, they may not be ideal for everyone. You may want to consider a personal line of credit if you’re facing unexpected expenses.

How Does a Personal Line of Credit Work?

A personal line of credit works much like a credit card. Once approved, you can tap into funds multiple times instead of getting the money as a lump sum. You can access the funds by initiating a bank transfer or withdrawing from the lending institution’s local branch. 

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Typically, a PLOC has a specific credit limit for the draw period. Therefore, you cannot withdraw more than the allotted amount during the term. Notably, a PLOC has an expiration date — once the period ends and you’d like to maintain the line of credit, you’ll need to reapply with the lending institution.

Like any other loan, a personal line of credit accrues interest, which begins immediately after you withdraw the funds. The lender charges interest for the withdrawn amount until you pay it off, on a preset repayment schedule. 

Good To Know

It’s important to keep in mind that personal lines of credit have maintenance fees, either monthly or annually. If you’re late to make payments, you may incur surcharges.  

Pros and Cons of Personal Lines of Credit

A personal line of credit may be helpful in some situations and not in other circumstances. As with any other personal finance decision, it’s vital to weigh the pros and cons before applying.

Pros

A personal line of credit comes with several advantages:

  • Easy access to funds: With a personal line of credit, you can borrow a set amount of money multiple times on an as-needed basis. This gives you the flexibility to access funds only when you need them, rather than one lump-sum payment. You can withdraw the money anytime, provided it’s within the draw period and you haven’t exceeded the credit limit allotted by your lender. 
  • No collateral required: Unlike secured credit cards that require collateral to borrow funds, a personal line of credit doesn’t require collateral. It can be an excellent option if you don’t have a home or other property to use as collateral.
  • Lower rates compared to credit cards: A PLOC has a lower interest rate than a credit card. However, the rate may vary by lender.
  • You pay only for the draws you make: With a personal line of credit, you pay only for the amount withdrawn plus interest.
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Cons 

While a personal line of credit comes with several benefits, it has its downsides, too:

  • High credit score required: Since a personal line of credit is unsecured, lenders require a high credit score, typically 690 and above. This means it’s hard to get approved for a PLOC if you have a poor credit history.
  • Risk of overborrowing: Although a personal line of credit has a limit over the draw period, it poses a risk of overborrowing if you don’t have a repayment plan.
  • High interest rates: A personal line of credit is an unsecured loan since the lender doesn’t take any collateral. This results in high rates because the lender assumes all the risk.

Is a Personal Line of Credit Right for You?

While a personal line of credit offers many benefits, it is not for everyone, so it’s important to choose wisely. As with any other loan, if you fail to make your loan repayment or are late to pay, it can negatively impact your credit score.

Personal Line of Credit Alternatives

A personal line of credit is one of the many products you can use if you’re looking for extra capital for personal use or unexpected expenses. If you don’t qualify for a PLOC or want some other options, here are three alternatives you may want to consider. 

  • Personal loan: Unlike a personal line of credit, where you receive funds in allotments, a personal loan is delivered in one lump sum — typically in as little as 24 hours.
  • Credit card: Another alternative to a PLOC is a credit card — it offers short-term financing, unlike a personal line of credit. However, most credit cards charge higher rates than PLOCs; and, if you don’t pay off your bill on time, you incur surcharges. 
  • Home equity line of credit: HELOC is a line of credit secured by your home. Essentially, you’re using your home as collateral to secure a loan. Since it’s a collateralized loan, rates are probably lower than a personal line of credit. 
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Good To Know

Before applying for a personal line of credit, it’s wise to compare lending institutions to ensure that you’re getting the best rates. Once you find one, make sure you read the fine print of the terms.

A personal line of credit can be a flexible way to borrow money when you don’t have an emergency fund. It enables you to borrow a set amount of money over a period of time. Plus, a PLOC provides quick access to funds whenever you need them, meaning you can draw how much you want anytime.

About the Author

Lydia Kibet is a freelance writer specializing in personal finance and investing. She's passionate about explaining complex topics in easy-to-understand language. Her work has appeared in GoBankingRates, Investopedia, Business Insider, The Motley Fool, and Investor Junkie. She currently writes about investing, banking, insurance, real estate, mortgages, credit cards, loans, and more. Connect with her on Twitter or moneycredible.com.

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