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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?
For one, a personal line of credit, or PLOC — which functions similarly to a credit card — is more difficult to qualify for. So it’s likely not an option for those who don’t already have strong credit scores.
Also, using a PLOC isn’t as simple as swiping a card. Using a PLOC can require transferring funds to your bank account, or even writing out a check. “I don’t think a personal line of credit is as convenient as a credit card or other payment options,” says 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. For those with high enough credit scores to qualify, a PLOC gets you access to funds at potentially much lower interest rates than credit cards. And the application process is similar to what you’d go through to get a personal loan. “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 Esq., 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 will fit your needs. Here are some of the advantages and drawbacks to using a PLOC.
What Is a Personal Line of Credit?
A PLOC is an unsecured, revolving loan you can get from a lender like a bank or credit union. You can borrow up to a pre-approved limit, but you pay interest only on whatever amount you’re borrowing at that moment. So if you’re approved for a $3,000 PLOC, but withdraw only $300, you’d pay interest on just the $300 until it is repaid. And when you pay back what you’ve borrowed, you can borrow that money again. In that way, it works similarly to a credit card.
You usually can access PLOC funds by writing a check or transferring the money into your bank account. Once you borrow from a PLOC, there’s a minimum monthly payment you’ll need to make.
A personal line of credit can be open for an indefinite amount of time, or it can expire after a number of years. This is known as the draw period. If it expires, you’d need to reapply for a new PLOC.
How to Find the Best PLOC
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 health.
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 … you can’t just look at the bottom line of how much you can borrow,” Tayne says.
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 are 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 want to avoid a PLOC that could require what is known as a balloon payment, where the balance is due in one lump-sum.
With interest rates as low as they have been over the past year, finding a fixed-rate PLOC is ideal. Unfortunately, the majority of PLOCs have variable interest rates. But this doesn’t mean you’re necessarily getting a bad deal. 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.
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.
When a Personal Line of Credit Can Make Sense
One of the biggest advantages of a PLOC is the flexibility to borrow only what you need.
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 unsecured 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.
While nothing beats having a healthy emergency fund, a PLOC can be a better last resort than a credit card because it’s usually a cheaper way to access cash. Credit cards charge higher interest rates on cash advances, in addition to cash advance fees. “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.
Use a personal line of credit as overdraft protection for your bank account so you never have to worry about overdraft fees.
You may even be able to set up a PLOC with your bank as a form of overdraft protection. This will help you avoid overdraft fees with the bank, and non-sufficient funds fees for payments that otherwise wouldn’t have gone through.
When a PLOC Doesn’t Make Sense
Without a strong credit score it’s likely the interest rate you could qualify for on a PLOC will be higher and close to what you’d pay on a credit card.
If that leaves you comparing a credit card or a PLOC, a credit card lets you avoid interest charges by always paying your bill in full and on time. A PLOC starts accumulating interest the day you make a withdrawal, so it’s not a good choice to use it for everyday spending.
Even if you have a healthy credit score, an unsecured line of credit will 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 home equity line of credit (HELOC) or home equity loan could be a better option.
Aside from potentially being more expensive than other forms of credit, especially secured credit, it can also be more complicated. A PLOC isn’t as simple as other loans, where you’d get all the money in one big chunk, and repay it over a set period of time. And it’s not as easy to use as a credit card. So it’s often not worth the effort to set up and use a PLOC.