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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 September 19, 2023
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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 expenses, debt consolidation, home remodeling projects, and more.Recommended: Line of Credit vs. Personal Loan

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. Similar to other types of loans, specifics vary based on the lender and its guidelines.

Personal Line of Credit Types

There are three types of personal lines of credit, including standard personal lines of credit, business lines of credit, and home equity lines of credit (HELOCs).

Personal Line of Credit

As discussed above, a personal line of credit is a revolving line of credit that can be used for practically any expense. It is typically unsecured, meaning it is not backed by collateral. Because of this, you’ll typically need a good credit score and a steady stream of income in order to qualify.

Business Line of Credit

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. Options for business lines of credit include:

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) differs from a personal line of credit in that you are borrowing against the equity in your home. Because your home is used as collateral, interest rates are typically more competitive. Typically, you can borrow up to 90% of the equity in your home and most lenders have a draw period of five to 10 years.Recommended: Personal Line of Credit vs HELOC

Secured vs. Unsecured Lines of Credit

Personal lines of credit are usually unsecured, but some lenders may allow them to be secured to either get a better interest rate or to qualify someone with fair credit or lower income. Types of collateral you can use may include a savings account, stocks, bonds, a vehicle, or other assets.Secured lines of credit could have a higher credit limit or a lower interest rate. If you have collateral that you’re willing to put up, it could be worth mentioning to your lender to see what your options are.

What to Review When Considering a Personal Line of Credit

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, like an auto balloon 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-only or a principal and interest payment. What makes this different is that 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.

How Does Interest Work for a Personal Line of Credit?

Personal lines of credit come with variable interest rates, meaning they will fluctuate over time. Variable rates usually start out lower than fixed rates, but if you are worried your rate may go up too high, you could consider a personal loan, instead. Personal loans, unlike personal lines of credit, typically charge fixed interest rates that do not change over the life of the loan. 

Fees Charged With a Personal Line of Credit

Fees that are charged with a personal line of credit will vary by lender. Common fees include application fees, origination fees, maintenance fees, transaction fees, and late payment fees. Since fees will vary, it’s best to shop multiple lenders and compare their fees and rates.

Overview: Pros and Cons of a Personal Line of Credit

The biggest pro of a personal line of credit is you only pay interest on what you use. Unlike a personal loan, where you’re given a lump sum of money and charged interest on the entire amount, a line of credit allows you to use what you need, pay it back with interest only on that amount, and use it again, if needed. It's a flexible form of borrowing that gives you full control.The biggest con of a personal line of credit is the interest rate may be high when compared to other forms of financing, and it’s usually a variable rate. That means the rate can fluctuate over time, usually increasing. This can make it hard to predict future payments.Let’s take a look at other pros and cons of personal lines of credit:
Pros of Personal Line of CreditCons of Personal Line of Credit
Flexible form of borrowingVariable interest rates
Only pay interest on what you useFees may be charged
Ability to use funds over and over againHard to qualify if your credit score or income is low
Collateral typically not requiredMay lower credit score if you run a high balance continually

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

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 score, 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 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.Recommended: What Happens to Personal Loan Debt If I Die?

Where to Secure a Personal Line of Credit

You can secure a personal line of credit at most financial institutions, including banks, credit unions, and online lenders.Each lender will offer different amounts, rates, and terms on their products depending on your personal financial profile. Lenders will also charge different fees, so it’s best to shop around and get quotes from multiple lenders before making a decision.

How to Apply for a Personal Line of Credit

Wondering how to apply for 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. To be prepared, it’s a good idea to check your credit score. If your score isn’t where you want it, you can work to build it prior to applying for a personal line of credit. You’ll also want to have an idea in mind of how much you want to borrow (most lines of credit range from $5,000 to $100,000), have your financial documents readily available, and compare multiple lenders so you can make sure you’re getting the best deal for your situation.

Personal Line of Credit vs. Other Loan Types

A personal line of credit isn’t the only form of borrowing available. Make sure to consider all of your options prior to deciding, including credit cards, personal loans, and payday loans.

Credit Cards

Credit cards work similarly to personal lines of credit in that you have a credit limit that you cannot exceed and the line is revolving. This means you can use up to your maximum limit, pay it off, and use it again. Historically, interest rates on credit cards are higher than with personal lines of credit. However, if you can pay your balance in full every month, you won’t pay any interest and may be able to rack up rewards or points depending on the type of credit card you choose.

Personal Loans

A personal loan is another option to consider. Instead of having a revolving line of credit, you’ll receive a lump sum that you can use for almost anything, including home renovations, car repairs, or consolidating debt.Before accepting the loan, you’ll be given your interest rate, term, and monthly payment amount. You’ll make payments on the loan each month until it’s paid in full. Interest rates for personal loans are usually fixed, so this is a good option for those that need a large amount of cash but want consistent, steady payments.

Payday Loans

While a payday loan may be tempting due to it being easily accessible, offering fast funding times, and not requiring a credit check, this is not usually a good route to go if you need financing. Payday loans come with extremely high fees, they don’t allow you to build your credit, and they often trap you in the cycle of debt.

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. With just a single application, you can view rates and terms by multiple lenders, all with no obligation to you.

Frequently Asked Questions

How much can I borrow with a personal line of credit?
Can I use a personal line of credit for any purpose?
Can I access the funds from my personal line of credit immediately?
Do I need to provide collateral for a personal line of credit?
Photo credit: iStock/Prostock-Studio
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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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