Personal Line of Credit: Definition, Importance, and How it Works?

A personal line of credit, or PLOC, is a loan that allows people to borrow money as needed up to a certain credit limit. A personal line of credit is like a credit card. It is because it is a flexible borrowing option that lets the borrower obtain money, make purchases, and repay the balance over time. A  personal line of credit has a lower interest rate than a credit card and has an extended repayment term. The main advantage of a personal line of credit is that it gives the borrower access to a source of funds. They are excellent for borrowers looking for the best personal loans for various purposes. These include paying for unexpected expenses, consolidating debt, or making a large purchase. Personal lines of credit are a good option for borrowers looking to obtain small loans on an ongoing basis. It allows them to fund various expenses over time. There are two main types of personal lines of credit. These include secured lines of credit & unsecured lines of credit. A secured personal line of credit is backed by collateral. Examples of collateral are a savings account or a car. They have a lower interest rate than an unsecured line of credit. An unsecured personal line of credit is not backed by collateral and has a higher interest rate.

What is Personal Line of Credit?

A personal line of credit is a loan where borrowers obtain cash as needed. These loans have a specified credit limit. It is like a traditional loan because it allows the customer to borrow money. But it differs in that the borrower accesses the funds as needed rather than receiving a lump sum all at once. A personal line of credit works like a credit card because it is a flexible borrowing option. Borrowers use it to buy anything and pay off the balance over time. A personal line of credit establishes a credit limit with a lender. Borrowers then choose to draw on as needed. The borrower accesses the funds by writing a check using a debit card associated with the line of credit. Some prefer transferring the funds to a bank account. As the borrower pays off the balance, the credit limit is replenished. Thus it allows the borrower to borrow more money as needed. The borrower must apply with a lender to open a credit line. These lenders include a bank or credit union. Lenders review the borrower’s credit history and financial situation. It helps them determine the credit limit and terms of the line of credit. Some lenders need borrowers to provide collateral for the loan. Examples include a savings account or car to secure the line of credit.

What is Secured Line of Credit?

A secured line of credit is a loan secured by collateral. Examples of collateral include a savings account, a car, or a piece of real estate. The collateral acts as security for the lender. Thus it protects them if the borrower defaults on the loan. Secured lines of credit have lower interest rates than unsecured lines of credit. One example of a secured line of credit is a home equity line or HELOC. A HELOC is a loan secured by the equity in a borrower’s home. The borrower borrows money up to a certain credit limit. The lender determines the limit. Borrowers access the funds as needed by writing a check or using a debit card. The borrower must make monthly payments on the loan balance. These payments include both principal and interest. Secured lines of credit are a good option for borrowers with collateral. Borrowers with less-than-perfect credit find it an excellent option. 

What is Unsecured Line of Credit?

An unsecured line of credit is a loan not backed by collateral. Lenders rely on the borrower’s creditworthiness and financial stability to obtain the loan. Thus, they have higher interest rates than secured lines of credit, as the lender is taking on more risk. Many lenders offer unsecured lines of credit. These include banks, credit unions, and online lenders. The borrower must apply with a lender to obtain an unsecured line of credit. They must provide information about their credit history, income, and expenses. Unsecured lines of credit are a good option for borrowers who do not have collateral.  

How does a Personal Line of Credit Work?

A personal line of credit establishes a credit limit with a lender. The borrower is free to draw on as needed. Borrowers access the funds by writing a check. Some transfer the funds to a bank account. The credit limit replenishes when the borrower repays the balance. Thus it allows the borrower to borrow more money as needed. A personal line of credit is similar to a traditional bank loan. It is because it allows the borrower to borrow money. The difference is that the borrower accesses the funds as needed rather than receiving a lump sum all at once. It is useful for borrowers who need access to a flexible source of funds on an ongoing basis.

How to Get a Personal Line of Credit? 

To get a personal line of credit, follow these steps:

• Determine borrowing needs. Borrowers must consider how much they need to borrow and how often they need to access the funds. It helps them determine the right credit limit and repayment terms for their needs.

• Shop around. Compare offers from different lenders to find the best terms and interest rates. Look at banks, credit unions, and online lenders to find the best deal.

• Check credit scores. Borrowers must check their credit report and credit score to ensure no errors. These affect their application.

• Gather documentation. They must have their financial information ready to provide to the lender. These include their income, expenses, and debts. They must provide proof of employment and identification.

• Apply. They must apply to the lender of their choice. They do it online or in person, depending on the lender.

• Wait for approval. The lender reviews the application and credit history to determine whether to approve the line of credit. Once approved, the lender provides borrowers with the credit limit and terms of the loan.

• Use the credit wisely. After getting the loan, borrowers must use it wisely. Besides, they must make timely payments to avoid accruing interest.

Credit score matters when getting a personal line of credit. Lenders use a borrower’s credit score to determine their creditworthiness and the risk of lending you money. Higher credit scores result in lower interest rates and more favorable terms. A lower credit score results in a higher interest rate and less favorable terms. It is because a high credit score indicates a borrower is. It shows they pay their debts on time. A low credit score means they are a higher-risk borrower more likely to default on the loan.

What are the Benefits of Personal Line of Credit?

There are several benefits of personal lines of credit:

• Flexibility. A personal line of credit lets borrowers access funds as needed rather than receiving a lump sum. It is useful for unexpected expenses or for covering ongoing costs.

• Credit building. Using a personal line of credit responsibly helps borrowers build their credit scores. These include making timely payments and keeping the balance low.

• Low fees. Personal lines of credit have lower fees than other loans, such as credit cards or personal loans.

• Multiple uses. A personal line of credit is used for various purposes. These include paying bills, covering unexpected expenses, or financing a large purchase.

What are the Downsides of Personal Line of Credit?

There are several downsides to personal lines of credit:

• Credit check. Obtaining a personal line of credit requires a credit check. Thus it impacts the borrower’s credit score.

• Interest. Personal lines of credit accrue interest on the borrowed funds. It makes them expensive if the balance is repaid slowly.

• Fees. Personal lines of credit may have fees. These include annual fees or maintenance fees, which add to the cost of borrowing.

• Risk of overborrowing. Personal lines of credit allow the borrower to access a large amount of credit, which is tempting. However, overborrowing leads to financial problems. These include high debt levels or difficulty making payments.

What are the other Credit Types other than Personal Line of Credit?

Personal lines of credit help borrowers who need a flexible source of funds. Borrowers use them to cover unexpected expenses. These include car repairs or medical bills that are not budgeted for. Personal lines of credit help cover ongoing expenses, such as rent or utility bills, when the borrower is temporarily short on cash. Using a personal line of credit responsibly helps borrowers build their credit scores and credit history.

How much is the Interest Rate of Personal Line of Credit?

As of 2022, the average interest rate for personal lines of credit was 98-10%. However, rates vary widely depending on the lender and the borrower’s credit profile. For example, borrowers with excellent credit obtain personal lines of credit with a low-interest rate. They are as low as 5%, while borrowers with poor credit pay rates as high as 20% or more.

What are the Fees Included for Personal Line of Credit?

Personal lines of credit have a variety of fees associated with them, including

• Origination fees. The lender charges a fee for processing the personal line of credit. The origination fee is typically a percentage of the loan amount and ranges from 1-5%.

• Annual fee. Some lenders charge an annual fee for maintaining a personal line of credit. The fee is typically fixed, such as $20 or $70 per year.

• Late payment fee. Suppose the borrower misses a payment or pays their personal line of credit balance late. Borrowers charge them a late payment fee. Late payment fees vary widely but are a percentage of the unpaid balance or a fixed amount, such as $25 or $35.

• Returned payment fee. Suppose a payment is returned due to insufficient funds or other issues. The borrower must pay a returned payment fee. Returned payment fees are typically fixed, such as $25 or $35.

How to Get the Fund from Personal Line of Credit?

To access the funds from a personal line of credit, borrowers generally have options. One option is to write a check using a personal line of credit. Most lenders provide personal line of credit borrowers with checks used to access the funds. The borrower writes a check to themselves or a third party to access the funds. Another option is to transfer the funds from the personal line of credit to the borrower’s checking account. Some lenders allow it to be done through their online portal. Another option is to use a credit card linked to the personal line of credit. The borrower uses the credit card to make purchases or withdraw cash from an ATM. 

How to Pay for the Personal Line of Credit?

To pay for a personal line of credit, borrowers have a few options. One option is to make monthly payments towards their balance. Most personal lines of credit need borrowers to make these payments. The borrower only chooses to pay the minimum payment. It is a set amount determined by the lender. Or borrowers choose to pay more than the minimum. Another option is to pay off the balance in full, either at once or over time. It is a good option for borrowers to pay off their balance quickly. It is because it helps them avoid accruing interest on the balance. Some lenders offer the option to set up automatic payments for personal lines of credit. These make it easier for borrowers to ensure that their payments are made on time. Additionally, some borrowers make additional payments on their personal line of credit to pay off the balance faster. 

Is Personal Line of Credit Hard of Obtain?

Obtaining a personal line of credit is difficult for some borrowers. However, it is not necessarily hard for everyone. The factors that make it harder for a borrower to obtain a personal line of credit include the following.

• Poor credit score. A low credit score makes it hard for a borrower to qualify for a personal line of credit. It is because lenders view the borrower as a high-risk borrower.

• High debt-to-income ratio. Borrowers with a high debt-to-income ratio find it hard to qualify for a personal line of credit.

• Lack of collateral. Some personal lines of credit need collateral, such as a home or car, to secure the loan. Borrowers who do not have collateral have a challenging time qualifying for them.

Is Personal Line of Credit an Open-End Transaction?

Yes, a personal line of credit is an open-end transaction. The borrower is approved for a certain amount of credit. However, they only borrow and pay interest on the amount of credit they use. The borrower uses the credit line multiple times as long as they do not exceed the credit limit. Suppose a borrower is approved for a personal line of credit with a credit limit of $10,000. They borrow and pay interest on any amount up to $10,000. In case they borrow $2,000, they pay it back and borrow another $2,000, or any other amount up to the credit limit, as needed. Open-end transactions, such as personal lines of credit, differ from closed-end transactions, such as traditional loans. It is where the borrower borrows a set amount of money and pays it back over a set period. Open-end transactions are more flexible and convenient for borrowers who need access to credit on an ongoing basis.

What is the Difference of Personal Line of Credit and Personal Loan?

Personal lines of credit and personal loans are two different financing options. Borrowers use them for various purposes. Here are the main differences between the two:

• Credit limit. Personal lines of credit have a credit limit. It is the maximum amount of credit the borrower is approved to borrow. Personal loans do not have a credit limit, and the borrower receives the full loan upfront.

• Interest. Personal lines of credit generally have variable interest rates. It means the interest rate changes over time. Personal loans have fixed interest rates. Thus the interest rate does not change during the loan term.

• Repayment terms. Personal lines of credit have flexible repayment terms. The borrower chooses to pay back the credit line as they use it. Personal loans have fixed repayment terms, with a set number of monthly payments over a set period.