Personal lines of credit provide access to capital on a rolling basis — a great type of financing for many people looking to pay for expenses as they arise. These types of loans are useful for a variety of situations, such as to pay for planned large purchases like appliances, or emergencies, including medical procedures or unexpected repairs.

A personal line of credit is similar to a credit card in practice, but it may be able to provide higher credit limits. If you're looking to make a large purchase or simply want available means to cover unexpected expenses in the future, a personal line of credit could be a good fit.

What Is a Personal Line of Credit?

A personal line of credit is a loan you can use as needed. It provides a source of ongoing funds you can access on an as-needed basis and up to a pre-approved amount. With a personal line of credit, you enjoy flexibility on how much you borrow and are only required to pay interest on the amount you've borrowed. Because a personal line of credit is a revolving loan, the funds replenish after you pay them back, and you can access the amount of the full line of credit once again.

The core aspects of a personal line of credit include:

  • As-you-need financing: Borrowers can access funds as needs arise, instead of borrowing a lump sum all at once
  • Instant access: Most draws initiate transfers to your bank account faster than a term loan, which means getting funds when you need it
  • Variable interest rates: Your personal line of credit will likely come with a variable interest rate, which changes based on economic conditions

How Does a Personal Line of Credit Work?

A personal line of credit is a type of personal loan that enables borrowers to access funds from a pre-approved amount, rather than simply borrowing a lump sum at one time. Whenever you borrow from an existing personal line of credit, you decide how much money you need, and the funds are transferred into your personal bank account. You then pay your lender back only the amount you've borrowed plus interest, regardless of how much you have been approved for.

Accessing Funds from a Personal Line of Credit

Once your lender issues a personal line of credit, you can borrow as much or as little as you want up to the maximum credit limit. That way, you only pay interest on the amount you actually "draw" from the total line of credit.

Interest Rates

Like most loans, interest rates on lines of credit are almost always contingent on your credit score — the higher your credit is, the more favorable your rate will usually be.

These loans commonly come with a variable rate credit, which means your rate will change throughout the term of the loan based on different economic factors. For instance, if the benchmark US interest rate rises or falls, your interest rate may change accordingly. Although it's possible your rate won't change from day one of your loan until the day it’s paid off, a variable rate means it can and likely will if economic conditions fluctuate.

Common Uses for Personal Lines of Credit

Many borrowers choose to have a personal line of credit should unexpected expenses arise, such as home repairs, medical expenses, or other emergencies. Others may use these funds to pay for pre-planned purchases.

Types of Personal Lines of Credit

There are two main types of personal lines of credit: secured and unsecured. Here is how the two are different:

Secured Personal Lines of Credit

Secured personal lines of credit require some kind of collateral, such as a bank account or personal property, to gain approval. Lenders often require collateral for borrowers who don’t have the strongest credit history. Or, collateral may serve to bring down interest rates, as secured lines of credit enable lenders to reconcile debt in case of default.

Unsecured Personal Lines of Credit

Unsecured personal lines of credit don’t require collateral. Not everyone qualifies for an unsecured line of credit since lenders tend to extend these unsecured loans to applicants with a stronger credit history. This is because an unsecured line of credit can be riskier for the financial institution supplying the financing without any borrower assets to back them.

Differences Between Personal Lines of Credit and Other Types of Borrowing

Personal Lines of Credit vs. Personal Loans

Personal lines of credit offer “revolving” access to capital, whereas personal loans provide the funds in one lump sum loan. With personal loans, you must pay interest on the entire loan, regardless of whether you use it all, whereas you only have to pay interest on what you draw with a personal line of credit. Further, with a personal loan, you must apply separately each time you want access to additional funding. With a personal line of credit, you have ongoing access.

Personal Lines of Credit vs. Credit Cards

Personal lines of credit are similar in structure, in that they provide borrowers with rolling access to a pre-approved amount of funds. Like credit cards, you only pay for what you use with payments usually being due on a monthly basis. However, credit cards often have higher interest rates and lower maximum amounts available to spend.

Applying for Personal Lines of Credit

Applying for personal lines of credit is generally straightforward, and may not require as much documentation as other types of loans.

Application Process

You can apply for personal loans through a few types of lenders such as banks or online lenders. Applications vary depending on your lender, but they generally share similar requirements in terms of information. Further, lenders as a whole evaluate candidates on many of the same criteria. In many cases, you can apply once you have your documentation together, such as financial statements, including tax returns, bank balances, and information on any other loans you may hold.

The Role of Credit Scores in Approval

Credit scores are a major factor in determining your approval for a personal line of credit. Personal credit scores are assessed on a scale up to 850. The higher your credit score, the better your creditworthiness, giving you better odds to enjoy loan approval. Credit scores are also directly tied to your interest rate. Higher credit scores in many cases mean lower interest rates and more favorable terms for borrowers.

Credit History and Debt-to-Income Ratio

Your track record of payments on present and past loans, including current credit card balances, is part of your credit history. Lenders will assess how long you’ve had credit and how responsible you have been with repaying in full and on time. Lenders want to see a strong history of repayment, which indicates you're a better candidate for a loan.

Lenders also look at your debt-to-income ratio, which is the comparison between how much you earn versus how much you owe. This ratio — the lower, the better — helps lenders make sure you have enough money coming in each month to cover your obligations going out.

Documentation and Other Common Personal Loan Requirements

Depending on the requirements of the lender, you may need to provide additional documentation, including tax returns and financial statements. Preparation is important — the more documentation you supply at the beginning of the process, the quicker the loan decision will be.

Advantages and Disadvantages of Personal Lines of Credit

Personal lines of credit can be extremely helpful, but it’s important to know their potential risks, too.

Pros of Obtaining Personal Lines of Credit

Personal lines of credit can provide you with the quick capital needed to make purchases, whether planned or in the event of an emergency. When you repay in full and on time, each draw incrementally helps you build credit. As long as you do not exceed your credit limit, you also don’t have to apply each time you need additional funding.

Potential Drawbacks and Risks

As with any loan, debt has risks, especially if you're unable to make monthly repayments. Lines of credit must be managed responsibly, both in terms of the time period in which you draw, as well as the amount you borrow. If you default on your personal line of credit, it can affect your creditworthiness, as well as trigger the seizure of any collateral you may have offered if the line was secured.

What If You Are Denied a Personal Line of Credit?

If you don’t qualify for a personal line of credit by a financial institution, you have two potential options to consider. The first is to wait to apply again until you have a stronger credit score and better standing in other metrics, like debt-to-income ratio. You can increase your credit score by responsibly handling repayments on credit cards and other loans, though it may take some time.

Conclusion: Is a Personal Line of Credit Right for You?

Taking on debt of any kind is a big choice, and should be handled wisely. The first step to understanding if a personal line of credit is right for you is gaining a strong understanding of your current financial situation, as well as what kind of payments you can handle and how to draw responsibly once you are approved. To make an informed decision, you can seek out the help of a financial professional, such as consultant at PNC Bank.