The Complete Guide to Personal Lines of Credit

We all could use a little extra income from time to time. From a stack of unexpected medical bills to expanding your living space for an aging parent — and everything in between — there’s always something around the bend.

One way to access that extra income fast is through an existing personal line of credit, also known as a PLOC. With the flexibility of a credit card (at a much lower interest rate), a personal line of credit can be a great option for some types of short-term expenses.

What Is a Personal Line of Credit?

When you’re approved for a PLOC, you’re approved to borrow up to a certain amount of money during a set time frame. Your credit limit and the time frame during which you can borrow are set by your financial institution or lender and are based on factors like your credit score and the amount of other debt you’re carrying.

How Does a Personal Line of Credit Work?

A PLOC is what’s known as a revolving line of credit. This type of credit gets its name from how you use it: borrow some, then pay it back, borrow again, pay it back again. You’ll draw from your PLOC using written checks. Here’s how it works:

1. Apply for, qualify, and secure your line of credit.

2. Receive a set of checks linked to your line of credit.

3. Use your funds anywhere that accepts checks as a form of payment.

4. Pay back what you’ve borrowed, plus any interest on that amount.

Credit Card vs. Personal Line of Credit

Credit cards and personal lines of credit are very similar. With a credit card, you charge up to a certain limit. Once you hit that limit, you can’t use that credit card anymore until you pay some back. But once you repay some of the expenses on your card, you can use it again until you hit your credit limit. Same deal with a personal line of credit.

The main difference is that you can use your credit card for as long as your account stays active, but a PLOC is only good for a certain length of time (often between six months and five years, although this varies). Credit cards also usually come with higher interest rates. Another difference is that credit cards are more widely accepted than checks.

Personal Loan vs. Personal Line of Credit

Although they sound similar, a personal loan and a PLOC are not the same. A personal loan is an installment loan. If you take out a personal loan of $2,000 to remodel your kitchen, then you’ll receive that $2,000 all at one time. If your remodel ends up costing more, you’ll need to take out a new loan or find another way to cover the extra costs.

With a PLOC, you might be approved for $3,000, but you can start with using just the $2,000 you need for your kitchen. If you realize you need more, you still have $1000 to work with.

Additionally, you only pay interest on the amount you borrow, not the total amount you’re approved for. If you’re approved for a limit of $3,000 but only borrow $1,500, you’ll only pay interest on the $1,500. With a personal loan, you’ll pay interest on the entire approved amount.

Rates, Terms, and Fees for a Personal Line of Credit

The rates, terms, and fees for a PLOC can vary a lot depending on the terms set by the lender and the creditworthiness of the borrower. However, financial website Value Penguin investigated current PLOCs and found that:

• The average term range is between six months and five years
• The average credit limit is between $1,000 and $100,000
• The average PLOC uses a monthly repayment schedule

Many PLOCs include at least some fees (this depends on the lender). If you’re considering a PLOC, it’s likely you’ll pay an annual maintenance fee of between $25 and $50. You may also be charged fees for late or returned payments.

Repayment Methods

Most PLOCs work like a credit card where you can charge expenses, repay some, and charge again. For instance, say you remodel your kitchen. You’re happy with the work, but your new kitchen makes your dining room look shabby. Once you repay your debt for the kitchen, you can then borrow from your PLOC again to redo your dining room.

Keep in mind other payment structures do exist. Each lender sets their own terms, so it’s important to discuss repayment options with a lender before taking out a PLOC.

Draw and Repayment Period

Some PLOCs designate a period of time when you can use your credit (or draw from it) followed by a separate period when you must make monthly payments on the amount you’ve borrowed. During this repayment period, you would not be able to borrow from your PLOC.

Balloon Payment

A balloon payment structure starts you off with small payments. Then, as time passes, your payments increase until you reach the largest payment at the end of your repayment period.

Although they have been popular in the past, most financial experts encourage borrowers to avoid a balloon payment structure. It can be more costly and less sustainable than a regular repayment structure, meaning you are more likely to default on your loan. Remember, never take out a loan you won’t be able to pay back comfortably.

Demand Line of Credit

With a demand line of credit, your lender has the right to call in your loan at any time. This is a risky repayment structure that most borrowers should avoid.

What Can a Personal Line of Credit Be Used For?

You can use a PLOC for just about anything. Some common uses include minor home improvements, medical procedures, consolidating debt, and buying or refinancing a car loan.

However, personal lines of credit are usually most helpful in limited circumstances when you’re:

• Borrowing a smaller amount of money
• Unsure of exactly how much you need to borrow
• Only need to borrow for a few years

Can I Use a Personal Line of Credit to Pay Off a Mortgage?

A PLOC is likely not a good option for paying off a mortgage. Most PLOCs are unsecured, so they have lower credit limits and higher interest rates. Further, the average length of a PLOC is only two to five years. In other words, your mortgage is likely to have much better terms than a PLOC and if not, you may be better off refinancing your mortgage.

Can I Use a Personal Line of Credit for a Down Payment?

Most mortgage lenders do not allow homebuyers to use a PLOC to make a down payment. Lenders look at factors like your debt-to-income ratio to evaluate whether you will be able to make your mortgage payments. Taking out a PLOC (or a personal loan for that matter) would increase your amount of debt, which may make you seem like a greater lending risk. In general, it’s not a good idea to open new lines of credit while you’re in the process of securing a mortgage loan.

Instead of using a PLOC for a down payment, you could:

• Save until you have the money for the down payment
• Explore down payment assistance programs through the National Homebuyers Fund, the U.S. Department of Housing and Urban Development (HUD), or local home-buying incentive programs
• Consider FHA loans for first-time homebuyers, which often require smaller down payments
• Investigate USDA or VA loans, which often require no down payment or one that is lower than other options
• Receive money from a friend or family member in the form of a gift (this often requires formal documentation)

Can I Use a Personal Line of Credit for Business Expenses?

A PLOC and a business line of credit are very similar. The main difference is that a business line of credit usually has a higher credit limit. So while you can use a PLOC for business expenses, you might receive better terms by applying for a business line of credit.

Does a Personal Line of Credit Affect Your Credit Score?

A PLOC does affect your credit score. When you apply for a PLOC, you’ll undergo a hard credit inquiry, which will temporarily impact your score. After approval, your PLOC will show on your credit report and factor into your credit utilization. Whether this is a good or bad thing will depend on your unique financial situation.

How a PLOC Can Improve Your Credit

If you aren’t carrying a lot of debt already and don’t have too many other new lines of credit, then a PLOC could improve your credit score if you make regular, on-time payments and don’t run up a high balance (usually considered to be 30% or more of your available credit).

How a PLOC Can Hurt Your Credit

However, if you’ve recently opened other lines of credit, then opening a PLOC could hurt your credit score. Similarly, if your other lines of credit are maxed out or your payments are irregular, your credit score will drop.

Importantly, most PLOCs are only available for a short time. When one expires, it can have a negative impact on your credit score because closing a line of credit changes your credit utilization rate.

You can offset the drop in credit from a hard inquiry or from closing a PLOC by practicing healthy credit-building habits like maintaining other long-term lines of credit, paying your bills on time, and keeping your credit utilization rate low.

How to Qualify for a Personal Line of Credit

Qualifying for a PLOC requires a good credit score, usually around 690 or higher. Because personal lines of credit are unsecured loans, meaning they do not require collateral, they are riskier for the lender and harder to qualify for. You’re more likely to be approved for a PLOC if you have:

• A long, reliable payment history
• A positive net worth
• A low debt-to-income ratio

Banks and credit unions offer personal lines of credit, although some online lenders offer them as well. Most financial experts agree that online lenders usually have less competitive rates. It’s important to shop around before applying for a PLOC to make sure you get the best terms.

The Takeaway

Like any type of credit, a personal line of credit is more effective at covering some expenses than others, and it must be used carefully since it impacts your credit score. But when a PLOC is the right tool for the job, its low cost and flexibility make it a great resource for managing cash flow and stretching your budget that much further.