What Is a Personal Line of Credit?

A personal line of credit grants you access to a set amount of cash. But unlike traditional loans, all the funds aren’t disbursed at once. You have the option to draw as much as you need at any given time and the available balance will be updated in real-time. Usually, payment is due from the borrower monthly, and the amount is based on the outstanding balance. So if you only draw from the line once, your payment will remain constant until the loan term expires. But if you initiate multiple draws, this number will change over time. 

To illustrate, if the bank approves you for a $5,000, three-year, line of credit and you decide to draw $1,000 for moving expenses, you’re available balance will be adjusted to $4,000 and can be accessed at a later date. And when your payment comes due, the amount will be based on the remaining months of the loan term and the applicable interest rate. 

Types of Personal Lines

There are two types of personal lines to choose from. 

Unsecured Line of Credit

If your credit score is up to par, most financial institutions will offer you an unsecured line of credit that is not backed by any form of collateral. So if you default on the agreement by withholding payment, they will not have access to your assets to recoup their losses. Their only forms of recourse will be reporting the delinquency to the credit bureaus and pursuing accelerated collection actions. 

Secured Line of Credit 

Having less than perfect credit doesn’t mean you won’t qualify for a personal line of credit, but chances are it’ll be secured. (And if the bank does give you the option to go unsecured, the interest rate may scare you away). 

With secured lines of credit, you’ll have to put collateral up to guarantee the loan. But here’s a major drawback: if you hit a rough financial patch and are unable to pay back what you owe, your assets could be at risk. In other words, the lender has the option to take ownership of the possession used as collateral to cover what you owe so they’re not forced to take a financial hit. 

Pros of a Personal Line of Credit 

Instant Access to Cash

No need to wait several days for your bank to fund a personal loan or for Aunt Susie to drop off the $500 you asked to borrow from her four days ago. With a personal line of credit, you can simply login into your online portal, request a draw, and the funds will be sent to your checking account in a jiffy. 

Fosters Credit Building

You don’t need an 800 credit score to qualify for an unsecured personal line of credit with a competitive interest rate. A score in the high 600s or better will get you through the red tape with the lender. But it never hurts to aim for a stronger score to qualify for better terms. 

Personal lines of credit are quite beneficial to your credit score in two ways: 

  • As long as you responsibly manage the line by making timely payments each month, your score will reap the rewards as payment history accounts for 35 percent of your credit score. 
  • If you don’t max out the line, your credit utilization ratio will decrease, which could mean good news for your credit score. Amounts owed account for 30 percent of your credit score, and the more unused credit you have at your disposal, the better. So by adding a personal line to your arsenal, you’ll automatically benefit if used responsibly. 

Lower Interest Rates

Compared to other debt products that can get your fast cash or purchasing power in an instant, personal lines of credit have relatively low-interest rates. Even better, you’ll only pay interest when you make a draw. But if you draw and remit payment before the grace period ends or are fortunate enough to never have to borrow against the line, you’ll pay very little if any interest over time. 

On the other hand, credit cards are accompanied by exorbitant interest rates that will keep you in debt for many years if you only make the minimum payment each month. Payday loans and cash advances are even more dangerous as their rates usually go well into three-digits (some states have no cap). And if you’re unable to repay the loan in the short time span of two or three weeks that they give you, additional fees are applied and you could find it impossible to dig yourself out of the hole. 

Drawbacks of a Personal Line of Credit

Higher Barriers to Entry

As mentioned earlier, getting approved for an unsecured personal line of credit could be a challenge if your credit score isn’t high enough. And unfortunately, low credit scores aren’t always caused by past financial challenges. Credit newbies or young adults without much experience under their belts face the same issue. 

If you’re relatively new to credit or have very little credit history and keep getting rejected for personal lines, it may be worthwhile to reach out to the lender and request a manual review of your application. The underwriter may be able to overturn the lending decision after taking a closer look, but you’ll never know until you ask. 

Increasing Payments 

Personal lines of credit are meant to be there when you need them, which is why you have the luxury of only withdrawing what you need when you need it. But it’s wise to pay back this amount as soon as you can to avoid getting stuck with payments for several months or years and paying interest. And you also want to steer clear of a high balancing resulting from several draws, which in turn means higher payments. 

Think about it: if you already have a hard time budgeting, adding another source of fuel to the fire will only make it harder to stay afloat. A better option: only draw what you’re certain you can afford to pay back in a short period to save yourself the grief. 

How to Get a Personal Line of Credit

The actual application process should only take a few minutes of your time. But before you apply, there are a few actions you should take to ensure you secure a personal line of credit with a low-interest rate that best suits your needs and financial situation. 

Here’s how to get started: 

Check Your Credit Score

When evaluating your application, your income and credit score will play a major part in the decision process. The lender wants to make sure you can afford to make the monthly payment if you decide to draw the maximum amount. But what’s even more important in their eyes is your creditworthiness or the likelihood that you’ll pay them back what you owe.

It all boils down to risk; if your credit score is in the trenches, they may decide not to take a chance on you and reject your application to cut their potential losses. But if they do give you a chance to rewrite your credit narrative, expect an offer for a secured product that requires collateral or an unsecured product with high interest. 

Start by visiting AnnualCreditReport.com to retrieve a free copy of your credit report from the three credit bureaus. Review the contents in their entirety and dispute any errors with Experian, Equifax, and TransUnion if needed.

Wondering why we start here? It’s the information in your credit report that determines your score. Furthermore, it’s impossible to know how you can improve your score without knowing what’s in your report. 

AnnualCreditReport charges a fee for your credit score but you can use a free tool, like Credit Karma, Credit Sesame, or the Discover Credit Scorecard tool to view your FICO score for free. It may also be available through your bank or on your credit card statements. But keep in mind that each lender uses a unique algorithm, so the score you see online may not be the same as what they see on their end.

Shop Around for the Best Rate 

Don’t settle for the first offer for a personal line of credit that catches your eye. Explore options from your current bank or credit union. Also, try online banks and lenders as most financial institutions have pre-qualification tools on their website, so you can see if your qualified and check your rate in minutes without impacting your credit. 

Narrow Down Your Options

The next step is to select the top three options from your list and dig a little deeper to determine which is the best fit. Make your top choice and proceed to the next step to submit a formal application. 

Complete the Application 

When filling out your application, be sure to follow instructions and answer the questions correctly. Doing so eliminates processing delays and can help you get access to funds sooner than later. 

Quick Note: The underwriter may request income and other documentation to substantiate your claims from the application, so be sure to have it on hand to send in if needed. 

Help! My Application Was Denied…

Bummer, but it’s not the end of the world. You have the option to apply with another one of the top lenders on your list. Or you can wait to hear back from the lender to determine why your application was declined. They may be willing to take another glance if there was some sort of error. 

But if credit is the issue, consider working to improve your score to boost approval odds on subsequent loan applications. Plus the higher your score, the lower the rate you’ll qualify for. 

Should You Apply? 

A personal line of credit with a low-interest rate can provide peace of mind to those who are working to build their emergency fund but would still like to know that they have a source of funds if life happens or they need even more money than they have saved to cover an emergency. Plus, you won’t spend a fortune in interest when it’s time to pay the money back.

But the key is to keep the draws to a minimum and only borrow what you need and can comfortably afford to pay back in a year or less (preferably six months). 

It may also be an ideal option for individuals with fluctuating income, like those who work solely on commission or who are self-employed. If you fall into this category, it’s a good idea to keep your expenses to a minimum and stash away as much as you can to smooth out your income in the months with lower sales volume. But until you reach that point, you can use a personal line of credit to fill the income voids as they come up. Just be sure to pay the money back when you’re back on the up and up.  

Wondering when doesn’t it make sense to apply for a personal line? It may not be a smart move if: 

  • You’re living check to check and can barely manage the expenses you have. As mentioned earlier, adding another obligation to what you already have is a recipe for disaster. 
  • You have more money than bills, but don’t save and run a deficit every month because your spending is out of control. In this case, you may be tempted to draw against the line to fund your “wants” and not “needs”, which will only lead to an unnecessary debt obligation for you. A better idea: create a budget, stick to it, and start to boost your safety net. 

It just depends on your financial situation, but it’s not a good fit if you’re looking for a quick fix to a major underlying or chronic financial problems, like soaring debt balances or irresponsible money management habits. 

The Bottom Line

A personal line of credit can provide a sense of financial security by giving you a source of funds to lean on when times get rough. But it shouldn’t be your only form of backup funding since it’s short-lived and comes at a cost. Instead, work at chipping away your debt balances and building a safety net to give yourself the best chance at establishing a solid financial foundation.