Personal Line of Credit: Get Flexible Cash When You Need It
A personal line of credit offers flexibility, but it's not a one-size-fits-all option.
October 14, 2022
Whether you need cash to consolidate debt, to buy a car, to purchase a home, to start a business or to handle an emergency, you can find a loan that meets your financial situation.
A personal line of credit (PLOC) is an unsecured loan that offers distinct features, including flexible monthly payments and few usage limitations. But this flexibility doesn't mean a personal line of credit is right for everyone.
Below, we’ll outline the basics of a personal line of credit to help you determine if it meets your personal finance needs.
What is a personal credit line?
A personal line of credit is a revolving credit account that can be used multiple times to pay for goods and services.
Similar to a credit card, a personal line of credit has a credit limit. You can borrow money up to that limit, and you only have to pay interest on the amount you use.
For example, if you have a personal line of credit with a limit of $5,000 and need help covering a $1,000 medical bill, you can draw $1,000 from your personal line of credit. You would still have $4,000 in available balance remaining, but you would only repay and pay interest on the $1,000 you borrowed.
When you’re approved for a personal line of credit, the lender gives you checks and a debit card you can use to access your funds. You can write checks or swipe the debit card just as you would with a checking account. You can also use the debit card to withdraw cash from an ATM.
Some of the key characteristics to pay close attention to when considering a personal line of credit include its draw and repayment periods as well as the interest rate you will be charged.
Personal line of credit phases
Most personal lines of credit have two distinct phases: the draw period and the repayment period.
Draw period
The draw period is the first phase of a personal line of credit. This is when you can use the line of credit to make purchases or pay for services. This period varies based on the terms of the line of credit.
During the draw period, you make payments on the balance you borrow. Most lenders give you the option to pay interest only or to make principal and interest payments while in the draw period.
If you have no balance on the line of credit at the end of the draw period, it closes.
Repayment period
If the draw period ends with a balance, you enter the repayment period. During this period, you can no longer draw money from the line of credit and must start making principal and interest payments on your account’s outstanding balance.
Like the draw period, the repayment period also varies based on the terms of the line of credit.
Personal line of credit interest rates
Personal lines of credit accrue interest, which is what the lender charges you to lend you money. Unlike most personal loans, a personal line of credit usually has a variable interest rate, meaning the interest rate may change over the life of the loan.
A personal line of credit with a variable interest rate may start with an introductory interest rate that's significantly lower than a fixed-rate loan. The downside is the introductory rate is only temporary and can eventually exceed a fixed-rate loan's interest rate.
Fortunately, a variable interest rate doesn't change on a whim. Instead, it follows the rise and fall of The Wall Street Journal's prime rate, which is based on the federal funds rate and a survey of 30 of the largest banks in the U.S. As of September 2022, Bankrate reports that APRs (annual percentage rates) for personal lines of credit can range from 3% to 36%.
When the interest rate changes, it applies from that moment forward — not retroactively.
When weighing your line of credit options, you want to consider more than just the initial interest rate. You also want to consider the rate-adjustment period, periodic rate cap, lifetime rate cap and a potential fixed-rate option.
Rate-adjustment period
Lines of credit with variable interest rates won't change without your knowledge. The loan agreement outlines its preset rate-adjustment periods. The lender can only change the interest rate on your line of credit during these periods.
Typically, rate-adjustment periods occur at the beginning of each month. However, lenders may set quarterly, semi-annual or other rate-adjustment periods.
Periodic rate cap
The periodic rate cap is expressed as percentage points and limits the number of percentage points your loan can increase during a rate-adjustment period.
For example, if your line of credit has a 1-percentage-point periodic rate cap, the lender can't raise the interest rate more than 1 percentage point during any rate-adjustment period.
Lifetime rate cap
The lifetime rate cap is also expressed as percentage points. It’s the cap on the overall number of points the lender can raise your interest rate during the life of the line of credit.
For example, if you take out a personal line of credit with a 10% initial interest rate and a 10-percentage-point lifetime rate cap, the interest rate will never exceed 20%.
Fixed-rate options
Some lenders give you the option of converting your line of credit balance to a fixed-rate loan. You can only make this conversion during the draw period, and the fixed interest rate will likely be higher than the initial variable rate.
Despite the higher interest rate, converting to a fixed-rate loan can prevent potential payment increases as the variable rate rises. The line of credit terms will tell you whether a fixed-rate option is available and outline its terms.
How much does a personal line of credit cost?
There’s more to determining the cost of a personal line of credit than the interest rate and the amount of money you need to borrow. You should also consider any fees associated with the account and if the line of credit is secured or unsecured.
Fees
A personal line of credit often comes with monthly or annual fees.
A monthly fee, sometimes referred to as a maintenance fee, is generally small but can add up to hundreds of dollars each year. An annual fee is a larger charge, but it only comes once a year.
Most lenders charge either a monthly or an annual fee — they rarely charge both. Other common fees include origination fees and application fees, which are charged when you apply for and open an account. Late payment fees and cash advance fees may also apply if you miss a payment or request a cash advance.
Secured vs. unsecured lines of credit
When borrowing money, you must also consider what you stand to lose if you default on the loan. Some loans are secured, including home equity loans, home equity lines of credit, auto loans and business lines of credit. This means you use collateral by putting up something valuable to secure the loan. If you default on a secured loan, the lender can seize the property to limit its losses.
Taking out an unsecured personal line of credit means you don’t need collateral for the loan. While the lender may still seize your property if you default on the loan, they must first get the judgment of a court.
What can I use a personal line of credit for?
There are generally few limits on how you can use a personal line of credit. This makes them far more flexible than auto loans and other specific-use loans.
Check your loan terms to see what restrictions, if any, the lender puts on the funds.
Some common uses for personal lines of credit include:
Home improvement and repair projects
Wedding expenses
Medical costs
Unexpected expenses
What is the maximum personal line of credit?
The amount of money you can draw using a personal line of credit will depend on several factors, though most lenders offer lines of credit with limits ranging from $1,000 to $100,000. The amount of money a financial institution will let you borrow can vary based on factors like your credit history and whether you already have a savings account or another account with them.
What credit score is needed for a personal line of credit?
Personal lines of credit generally require a good credit score — meaning a FICO® Score of 680 or higher — and a low debt-to-income ratio. An excellent credit score could help you qualify for lower interest rates.
Because unsecured personal lines of credit have no collateral securing them, lenders often have strict creditworthiness requirements and higher interest rates than secured lines of credit.
What is the difference between a personal loan and a line of credit?
A personal loan is an installment loan that is disbursed as a lump sum, and you will start repaying the loan right away through equal monthly payments. Meanwhile, a personal line of credit is a form of revolving credit that can be reused as many times as you’d like. The only limitations are the credit line limit and the length of the draw period. As revolving credit, you only pay interest on the amount you use.
Is a line of credit a good thing to have?
Determining whether a personal line of credit is right for you requires a deep dive into your financial needs and goals. Then, compare your needs to what a line of credit can offer you.
When a personal line of credit may be right for you
If the following points are true for you, you might consider a personal line of credit:
You have an immediate need for flexible cash.
You want a lower interest rate than a credit card can offer.
You're uncertain exactly how much cash you need.
You only need backup funds.
You want the lowest possible initial minimum monthly payments.
You lack the equity for a home equity line of credit (HELOC).
You don't want to put a vehicle or home up as collateral.
You have a good credit score.
When a personal line of credit may not be right for you
There may be some reasons a personal line of credit isn’t the best option. If one or more of the following descriptions applies to you, you may want to look at other possibilities:
You lack a good credit score.
You need access to a line of credit for longer than the draw period allows.
You want a fixed interest rate.
You know the exact amount you need to borrow.
You have enough home equity to qualify for a HELOC.
You tend to max out credit cards when you have them.
Your priority is a low interest rate.
Find the right option for getting flexible cash
A personal line of credit gives you flexible cash when you need it. With high borrowing limits and the ability to draw and repay cash as needed, you can have greater flexibility to pay down debts, manage unexpected expenses or even take care of household repairs.
If you’re trying to pay off credit card debt, Tally† may be able to help. Tally offers a lower-interest personal line of credit to pay down your existing higher-interest credit card balances so you can get out of debt more quickly and efficiently.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.