Personal Line of Credit

Personal Line of Credit Definition and Meaning

A personal line of credit (PLOC) can give you on-demand access to credit for major expenses. In some cases, a PLOC can give you more flexibility than a personal loan, and lower costs than a credit card.

However, PLOCs can be tricky. It’s especially important to understand all the fees and interest charges. That way you can make sure a PLOC would be more cost effective than a regular loan or a credit card. 

Key Features of Personal Lines of Credit

The details of PLOCs vary, but here are some common features:

• You can draw on the line of credit when you need it.

• There is some flexibility for how quickly you pay back what you’ve borrowed.

• You are approved to borrow up to a certain amount (that's your credit limit).

• You may be required to pay back a certain minimum amount every month.

• You only pay interest when you have a borrowed balance outstanding.

• Interest rates are often (but not always) lower than typical credit card rates. 

• The interest rate may vary over time.

• In addition to interest, there may be set-up fees, annual fees, and/or transaction fees.

• You generally need good credit to qualify for an unsecured personal line of credit.

Comprehensive Breakdown: How a Personal Line of Credit Works

A personal line of credit works in a fairly similar way to a credit card. You can tap into it whenever you want. You have a fair amount of flexibility in terms of how quickly you pay it off, as long as you meet the minimum monthly payment requirement.

That flexibility is the key advantage a line of credit has over a personal loan. Let’s say you’re starting a big home improvement project and are uncertain about how much money you’ll need to see it through, and when you’ll need it.

With a loan, you’d borrow the money all in one lump sum, and immediately start paying interest on the full amount. With a line of credit, you only pay interest when you’re actually using the money. That can make the line of credit more cost effective than a loan.

At the same time, while a line of credit has some similarities to using a credit card, the key difference is that interest rates on lines of credit are typically lower than credit card rates. That can make a PLOC more cost-effective for big-ticket items, and when you won’t be able to pay back what you owe quickly.

While a line of credit can be useful, it’s important to understand the details before you sign up. Besides charging interest, lines of credit often have fees. These may include fees to initiate the line of credit, regular fees to maintain the line of credit, and transaction fees whenever you tap into the line of credit.

These fees are often a fixed amount, rather than a percentage. As a result, they can represent a large proportion of smaller amounts of money. For example, if you borrowed $5,000 from your line of credit, a $50 transaction fee would represent 1%. That’s not too bad. However, if you borrowed $250 from your line of credit, that same $50 fee would represent 20%. On top of whatever interest rate the line of credit charges, that would be a big expense.

So, find out what the fees will be before you sign up. In general, it’s best to use a line of credit for larger transactions. If your line of credit has a transaction fee, an ordinary credit card might be more cost-effective for smaller transactions.

Types of Personal Lines of Credit

Here are some common types of PLOCs:

• Unsecured personal lines of credit. These require no collateral, so you get maximum flexibility. Being able to qualify is likely to depend on having a good credit record and a solid income compared to your regular expenses.

• Secured personal lines of credit. These require some money or property to be put up as collateral. That might reduce some of the flexibility you’d get from having a line of credit. However, this type of PLOC might help you build your credit record.

• Linked personal lines of credit. These work in tandem with a deposit account at the same bank. For example, a PLOC can be used to top off your checking account automatically to avoid overdrafts. However, if the line of credit has a transaction fee, you may be better off just paying an overdraft fee.