What is a Personal Line of Credit?

researching a personal line of credit on the computer
A personal line of credit is a flexible loan that can be accessed on a month to month basis to cover any income gaps. Although you can access a line of credit in a similar way to a checking account, interest is only applied to the amount spent rather than the full credit limit. Banks commonly offer personal lines of credit to business owners to cover expenses, however, any individual with a credit standing can apply. Unlike loans, personal lines of credit do not require you to provide intent in the form of a business plan, or in depth financial plans making them easy to use for any expenses.

How do personal lines of credit work?

After going through the application process, a lender will draft a contract that uses the business or person’s financial standing and lending history to calculate the credit limit, payback terms and annual percentage rates. For individuals with strong credit standing, a personal line of credit can be approved for up to $100,000 though certain lenders.

Once the account maximum has been set, a borrower will gain access to an account where they can withdraw funds similar to a checking account. Most personal line of credit accounts can be accessed and managed online and allow you to transfer funds to checking accounts. Once funds are withdrawn from the credit account, the borrower will be accountable to pay interest until the full amount is paid back. Depending on the personal line of credit contract, you may only be accountable for interest on funds not returned to the account after a month term.

What is the difference between unsecured and secured credit?

illustration showing the difference between secured and unsecured credit
Unsecured credit requires no collateral or upfront payments and typically have a higher annual percentage rate than secured lines which require a collateral.

Secured credit lines are more common for large amounts of credit such would be used to purchase a home, automobile or to finance college. For larger loans, collateral is used as security for the lender in case the loan is defaulted on. This is to ensure that if a borrower fails to repay the loan, the bank will still have funds to recuperate the losses.

When do you use a personal line of credit?

Daily spending, paying off debts with a higher annual percentage rate or paying bills due before a paycheck clears are all common uses of a personal line of credit. Larger purchases like homes, automobiles, student loans and any other big ticket items may not be the best use of a secured loan as they will take a longer term to pay off. As a general rule, do not use a personal line of credit for items you intend to pay off over a longer term. The annual percentage rate of a personal line of credit may not work in your favor over a longer period for larger purchases.

What is the difference between a personal loan and personal line of credit?

Although a personal loan and a personal line of credit are both forms of unsecured lending, a personal loan accounts for a large sum of money given all at once, whereas a line of credit works more like a credit card. A personal loan has a multitude of uses, but these are more limited than a personal line of credit. Depending on the lender, a personal loan may require intent of use before becoming approved.

A personal loan may be a better option if you need to make a one-time large purchase that you will pay off over time. As the annual percentage rates tend to be lower on personal loans than on personal lines of credit, they could offer lower associated costs.

Applying for a personal line of credit with bad credit

Although a major factor for drafting a personal line of credit is a borrower’s credit score, individuals with low scores can still secure a personal line of credit. Some lenders will adjust the annual percentage rate, lower the total credit limit and potentially ask for a collateral. Collateral either in a cash or asset form will be taken from the borrower if the credit can not be repaid.

Personal lines of credit are flexible, so they are great for covering any number of expenses, but it is important to pay off the borrowed amount quickly. If you have poor credit the annual percentage rate on the amount owed can quickly get out of hand, causing more financial stress.

As your credit history will determine the amount, terms and interest rate on a personal line of credit, it is best to make sure your credit score is in good standing before borrowing. Investing in your credit score can lead to large cost savings if you are negotiating for a personal line of credit or loan. Credit repair services can help you remove negative entries from your credit history which will have a positive impact on your credit score, making it easier to negotiate for better loans and lines of credit.