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What is a Personal Line of Credit and How Does It Work?

What Is a Personal Line of Credit & How Does It Work?
Kelly Boyer Sagert
Kelly Boyer SagertUpdated February 25, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
You may be more familiar with using credit cards and personal loans than with using a line of credit for personal purchases. So, what exactly are personal lines of credit? What are the pros and cons? Is it the right decision for you? Use this post to compare advantages and disadvantages. 

What is a Personal Line of Credit? 

A personal line of credit (PLOC) is a revolving form of credit that blends some elements of a personal loan with those of a credit card. After you apply and are approved for this type of loan, the financial institution provides you with access to a certain amount of funds (a credit limit) for a predetermined amount of time (the term). You can use funds from a personal line of credit to pay for medical or legal expenses, car repair bills, to consolidate debt, remodel a home, and more. 

How Does a Personal Line of Credit Work?

After an applicant is approved for a personal line of credit, they’ll have a credit limit (similar to a spending limit on a credit card) that they can use as they see fit. This differs from a personal loan where funds are given in a lump sum and are paid back in regular installments of principal and interest. With personal lines of credit, interest accrues on the amount you’ve drawn out and, as funds are paid back, they can often be reused in a revolving fashion like a credit card. Just like with other types of loans, specifics vary based on the lender and its guidelines.If you're a business owner, you might be more interested in a business line of credit (BLOC). It can be helpful to see how a business line of credit works. Here are a few resources to learn more about these loans:Wondering how to get a personal line of credit? In general, you’ll fill out a loan application in-person or online with a financial institution that offers this type of funding. As far as how to qualify for a personal line of credit, key factors for approval include good credit scores and history. The lender will also likely check your employment history and income to determine if you have the resources to pay for funds drawn. 

Personal Line of Credit Types 

Personal lines of credit can vary in multiple different ways, including:
  • Draw and repayment periods
  • Balloon payments
  • Demand features
Here are more specifics about each.

Draw and Repayment Periods 

If considering a particular lender, ask about their draw period — the predetermined amount of time when you can draw upon funds. For example, a lender may have a two-year draw period, or one that lasts three or five years. During that time, as amounts are being paid back, you can typically draw upon more funds up to the credit limit again.In the repayment period, no new funds can be drawn out. During this time frame, the borrower would pay back outstanding funds in payments that include both interest and principal. It can make sense to compare draw and repayment periods among lenders to see which ones dovetail most closely with your needs. 

Balloon Payments 

Sometimes, a personal line of credit comes with a balloon payment, which is a larger-than-usual one-time payment at the end of the loan term. Under those circumstances, at a predetermined time, you’d need to pay off the outstanding balance and, depending upon how much was used and how much had already been paid down, this could be a large amount. The Consumer Financial Protection Bureau therefore recommends that you consider your ability to meet the balloon payment before applying for a loan that has one.

Demand Line of Credit 

With a demand line of credit, you can borrow up to the credit limit and make payments on the amount to free up more to borrow again. Payments may be interest online or a principal and interest payment. What makes this different: the lender can call in the amount due at any time — meaning in full. So, like with balloon payment lines, consider your ability to pay the loan back in full on demand before agreeing to this type of loan.

Benefits of Using a Personal Line of Credit 

Benefits of personal lines of credit can include the following (depending upon a lender’s guidelines):
  • No collateral required
  • Competitive rates
  • Only pay for draws made
  • Quick access to funds
  • Overdraft protection
Learn more about the benefits.

No Collateral Required 

Typically, personal lines of credit are unsecured loans, which means that you don’t need to put up collateral (an asset such as a car or house) to get the loan. So, even if you can’t make payments on time, you don’t have an asset that could be foreclosed upon. However, making late payments doesn’t mean there won’t be negative consequences, especially when it comes to your credit score.

Competitive Rates Compared to Credit Cards 

When considering a personal line of credit vs credit cards, it’s important to know that rates for lines of credit, even when unsecured, are lower than what you’ll likely get on a credit card. Plus, the better your credit scores, the more possibilities there will be for you to receive the best rates currently available. 

Only Pay for the Draws You Make 

With personal credit lines, you’ll only pay on the outstanding balance. So, you could have, say, a $30,000 line of credit, but if you’ve only used $10,000, payments will be based on the $10,000 rather than the full $30,000.

Quick Access to Funds

Once you’ve established a line of credit, there can be fast ways to access cash, as needed. Depending upon your lender, you can get cash at your local branch or online, or perhaps through a mobile app. Some lenders will give you checks to use to draw upon the line of credit or give you a debit card for that purpose.

Overdraft Protection 

Some lenders will allow you to use your credit line as a form of overdraft protection. Say, for example, a check is written for more money than what’s available in the account. In that scenario, the overage owed would go onto the line of credit and prevent the borrower from having to pay overdraft fees or having a check bounce.

Disadvantages of Personal Lines of Credit 

Although there are plenty of benefits, personal lines of credit also come with disadvantages, which can include:
  • Risks of over-borrowing
  • Difficult to qualify for with poor credit
  • Interest isn’t tax deductible
  • Higher interest rates
  • Interest rates vary

Run the Risk of Over-Borrowing

Because it’s easy to access funds once a line of credit is established, it’s also easy to draw upon more than what you can comfortably pay back. Examples include lines of credit that can come with large balloon payments or ones that can be called in at any time — but even a more typical line of credit could be the source of over-borrowing.

Difficult to Qualify With Poor Credit 

In general, lenders consider unsecured loans to be riskier than secured ones because they aren’t backed by collateral. So, financial institutions will prefer to approve lines of credits for borrowers with good credit scores, making it more challenging for people with less-than-stellar ones.

Interest Isn’t Tax Deductible 

Although there are a few exceptions, you typically can’t write personal loan interest off on your taxes. If you use some or all of the funds for business expenses, in taxable investments, or to pay qualified higher education expenses, there may be some tax deduction possibilities. Check with your accountant or financial planner for specifics.

Higher Rates Than HELOCs 

Because lines of credit being discussed here are unsecured, they’ll almost certainly have higher interest rates than secured loans, including home equity lines of credit (HELOCs) and other mortgage and car loans. 

Interest Rates Vary

First, lines of credit almost always have variable rates based on a certain index. This means that, even if you’re happy with the starting rate, it can go up based on the loan agreement parameters. Plus, interest is calculated on a loan that can have draws taken out and payments made on a less strict schedule than, for example, with installment loans, so it may not be as simple to realize how much you’re accumulating in interest charges.

The Takeaway 

A personal line of credit (PLOC) is a revolving form of credit that mixes the features of a personal loan with those of a credit card. If you’re ready to dive in and compare personal loan options, Lantern by SoFi makes it easy. Plus, here are a few tips to consider when applying for a personal loan.
Photo credit: iStock/Prostock-StudioThe tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. SOLC0122072

Frequently Asked Questions

What is the difference between a personal loan and a personal line of credit?
How long do you have to pay off a personal line of credit?
Can I use my line of credit for anything?
Should I accept a line of credit?

About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.
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