Personal Line of Credit: How It Works and When to Use One

A personal line of credit has more flexibility than a personal loan, and offers a significantly lower interest rate than a credit card.

So why don’t you hear about them more often?

A cross between a personal loan and a credit card, a personal line of credit -- or PLOC -- has its own particular features, advantages and drawbacks. A PLOC offers the flexibility of borrowing the money you need, when you need it, but typically requires a good credit score to obtain. Personal lines of credit offer lower interest rates than most credit cards, but are also less convenient to use, according to Suzie Kisslan, chief operating officer at Credit Union of Southern California. 

But that doesn’t mean you should ignore the potential benefits of opening a PLOC. As long as you can qualify for a favorable interest rate and you’re able to pay it back what you borrow, a PLOC can be a good way to finance an ongoing project with uncertain costs or keep around as a supplement to your emergency fund. “A PLOC is nice to have as a backup -- you don’t have to draw on it, but it’s nice to have if something unexpected occurs and you don’t have a substantial emergency fund,” says Leslie Tayne, attorney and founder of Tayne Law Group, a New York City law firm specializing in debt relief. 

If you’re considering opening a personal line of credit, you’ll want to be sure it fits your needs. Here are some of the advantages and drawbacks to using a PLOC.

What is a personal line of credit and how does it work?

A personal line of credit is a type of revolving loan. Instead of receiving a lump sum of money, like you would with a personal loan, you’re given a credit limit that you can draw against, similar to a credit card. You can draw from your account as often as you’d like, as long as you don’t exceed the total PLOC amount. 

Most PLOCs have a draw period -- a set period of time where you can withdraw money from the line of credit. After the draw period ends, your line of credit will close, and you’d have to reapply for a new PLOC, if needed.

You can usually access PLOC funds by writing a check or transferring the money into your bank account. Some lenders may offer access to your funds via card. Once you start withdrawing from a PLOC, there’s a minimum monthly payment you’ll need to make. 

 Though personal lines of credit offer some flexibility, there are some guidelines:

• Loan amounts. The maximum amount offered depends on the lender, but PLOCs typically run between $1,000 and $100,000. Your maximum loan amount, terms and rates depend on a handful of factors, such as your creditworthiness and risk profile. 
• Repayment structure. Unlike credit cards, personal lines of credit typically have a defined draw period. This is a fixed timeframe in which you can borrow money from your loan. Interest starts to accrue as soon as you withdraw money from your personal line of credit, and you’ll typically have to make minimum monthly payments once you borrow from your PLOC. When your draw period is over, you’ll no longer be able to draw from your line, and if you’ve not repaid the PLOC in full, you’ll make payments toward your balance. Different lenders may have different repayment structures and terms for their PLOCs, so be sure to check your terms and conditions to know exactly how your specific PLOC works.

Personal lines of credit vs. personal loans

While they sound similar and do share similarities, a personal loan is an installment loan and not a revolving credit line. With a personal loan, you receive the entire loan amount in a lump sum upfront and repay the loan with fixed monthly payments, or installments. With a personal loan, you can’t borrow additional funds down the line without applying for a new, separate loan. Personal loans tend to have fixed interest rates, meaning the rate you lock in at the beginning of the loan will be your rate for the entire duration. Personal lines of credit are generally variable-rate products, with interest rates that fluctuate based on the prime rate -- though fixed-rate PLOCs do exist. 

Secured vs. unsecured lines of credit

Typically, a personal line of credit is unsecured. This means it’s not backed by collateral such as a car or home. A secured line of credit is backed by collateral. One example of this is a home equity line of credit, or HELOC, where the collateral is your house. 

The obvious advantage of an unsecured line of credit is that you don’t need to offer up -- and risk forfeiting -- a major asset to get the loan. Because unsecured loans are seen as riskier than secured loans, their interest rates tend to be higher and their credit score requirements tend to be stricter.

Secured lines of credit tend to have lower interest rates and are easier to obtain. You typically don’t need as high a credit score as unsecured lines of credit. The biggest drawback is that you’ll first need to have an asset you can offer as collateral and you’ll need to be comfortable with that arrangement.

Advantages of personal credit lines

• Helpful if you have upcoming expenses, but do not know exact amounts: One of the best features of a personal line of credit is its flexibility, explains Michelle Lambright Black, a credit expert and founder at CreditWriter.com. “This comes in handy when you don’t know exactly how much money you need to borrow for a project,” says Black. “For example, with home repairs and home improvement projects that you’ll complete in incremental steps, you may not know the final cost in advance.” 
• Flexible access to cash: With credit cards, you generally borrow money by charging purchases to your credit card, rather than getting cash in your bank account. “Personal lines of credit may serve you better than credit cards in situations where you need flexible access to cash,” says Black. “Although a credit card may give you the ability to request cash advances, the associated fees tend to be quite expensive.” For example, if you need to borrow money to make your car payment, you generally can’t do so with a credit card but you can use a PLOC to draw funds, have the funds deposited into your bank account, and then use that to pay your car loan lender.
• Fast access to funds: Once approved, some online lenders can provide access to funds in as little as one business day. 
• Lower rates than credit cards: The annual percentage rates, or APRs, for a personal line of credit vary, but they’re typically lower than the standard APRs on credit cards (excluding credit cards with introductory 0% APR offers). The stronger your credit score, the better rate you’ll be eligible for. 

Risks of personal credit lines

• Harder to qualify for: Personal credit lines can be tougher to qualify for than secured loans like home equity lines of credit, since they’re riskier for the lender.
• Higher rates than other lines of credit: Unsecured personal lines of credit tend to have higher interest rates than many fixed-rate loans and secured lines of credit.
• Variable interest rates and variable monthly payments: Like credit cards, personal lines of credit typically have variable interest rates, which are tied to the prime rate. That means that your interest rate -- and by extension, your monthly payment -- can fluctuate if market conditions change. Do not take out a personal line of credit unless your finances can withstand an unexpected spike in your monthly payment. 

What’s the difference between a line of credit and a credit card?

Both are revolving loans: You have a credit limit and you repay as you go. And they’re both unsecured. The key difference is that a line of credit typically has a lower interest rate than a credit card as well as an initial draw and repayment period. Once this repayment period starts, you won’t be able to draw from your LOC. 

A credit card will have a maximum spend limit, but you can keep spending indefinitely -- without paying any more than the minimum amount back each month -- until you hit it, as long as your account remains open and in good standing. Unlike a PLOC, credit cards typically have a grace period between the end of the billing cycle and when your bill is due where interest won’t accrue on the charges in that cycle’s statement. As long as you pay your balance in full by the due date, you won’t pay any interest. By contrast, interest on a PLOC accrues the moment you draw from your line of credit.

It’s also worth noting that credit cards often offer cash-back rewards, 0% APR offers and other perks, while PLOCs typically don’t. 

When to use a personal line of credit

• If you’re not sure how much you need for a project. Let’s say you plan on doing some home repairs and home improvement projects that you’ll complete in incremental steps. In that case, you may not know the final cost in advance. “A home equity line of credit may work better in certain situations,” says Black. “But if you don’t have sufficient equity in your home or if you don’t want to secure a line of credit with your home, a personal line of credit could be an alternative worth considering.” 
• You’re incurring a large expense over time, rather than upfront. One of the benefits of lines of credit over installment loans is that interest starts to accrue only on the amount you draw, at the time you draw it. For example, if you’re spending $10,000 on a home remodel, and 50% of the bill is due upfront with the other 50% due when the job is done, a PLOC can be a cheaper option than an installment loan. With any type of loan you’d start paying interest on the full $10,000 from day one. But with a PLOC, you’ll only pay interest on the first $5,000 initially, delaying interest charges on the second $5,000 until the work is done and you’ve withdrawn the remaining funds. 
• You want some extra security in addition to your cash emergency fund. While you should ideally have an emergency fund of several months’ expenses in cash, a HELOC can be a good addition to your emergency fund for some extra security. “People get lines of credit for emergencies, and you don’t ever pay interest if you don’t take an advance on your line,” Kisslan says. If you need to draw from your line of credit in an emergency, PLOCs typically offer lower interest rates than credit cards.

When a personal line of credit might not be a smart idea

• For big-ticket items with a fixed price. A personal line of credit usually isn’t a good fit for large, fixed purchases, explains Black. When you know much you’ll need in advance, there are less expensive financing options. “If you wanted to finance the purchase of a recreational vehicle, for example, a fixed-rate installment loan would probably be the more affordable option,” says Black. 
• If you have poor credit. To land the best rates, you’ll need to have a pretty strong credit score. In turn, personal lines of credit also may not be the best fit if you have bad credit, says Black. “Lenders typically have stricter approval requirements for lines of credit than they do for personal loans,” says Black. So, you could have a tough time qualifying for a personal line of credit if you have credit challenges like low credit scores, no credit or perhaps a thin credit file.
• If you need long-term financing. It’s also important to keep in mind that lines of credit tend to come with an expiration date, explains Black. “At some point in the future, you may no longer be able to draw against your credit line,” she says. “If you’re looking for a source of financing that you can keep in reserve for emergency situations, a credit card may be the better choice.” 
• You can qualify for better options with lower rates. Even if you have a healthy credit score, an unsecured line of credit will typically have a higher interest rate than a secured loan or other secured line of credit. So if you have enough equity in a property, a HELOC or home equity loan could be a better option, though it can be riskier if you’re unable to repay your loan.

How to find the best personal line of credit

The application process for getting a PLOC is similar to what you’d go through to get a personal loan. And, just like with any loan, the rate and terms depend on the lender and your credit profile. 

Shopping around for the best deal on a PLOC is important because there’s a lot of variability in the specifics of how PLOC functions. You should look at the interest rate, repayment process, and fees. “The terms are really important in a personal line of credit,” Tayne says. “You can’t just look at the bottom line of how much you can borrow.”

Repayment terms

A PLOC’s repayment terms are similar to what you’d get with a credit card. When you make a withdrawal on your PLOC you’ll need to start making monthly payments. These payments can be a fixed amount or can change as you use more of your available credit if they’re calculated as a percentage of your balance.

Also, if the PLOC has an expiration date, find out what the repayment terms will be if you have a balance after the line of credit expires. You might want to avoid a PLOC that could require what is known as a balloon payment, where the balance is due in one lump-sum -- unless you plan for this upfront.

Interest rate

In a rising interest rate environment like the one we’re in now, finding a fixed-rate PLOC is ideal. The majority of PLOCs, however, have variable interest rates. But if you need a PLOC for only a short period of time, it’s possible you’ll never be impacted by a rate adjustment. So when shopping for the best rate, pay attention to when the interest rate will reset, and how often it can change after the initial adjustment.

Fees

You should ask about what fees the lender may charge. Some PLOCs have an application fee, charge yearly maintenance fees and may even have a prepayment penalty. But none of these fees are standard for every PLOC, so comparing fees is important.

This article includes some material that was previously published on NextAdvisor, a CNET Money sister site that was also owned by Red Ventures and which has merged with CNET Money. It has been edited and updated by CNET Money editors.