Consumers often don't realize the wide range of options available when they want to borrow money. Most people have a credit card, and many have auto loans and mortgages, but fewer use a personal line of credit. Similar to a credit card, a personal line of credit is an unsecured revolving credit account with a maximum credit limit. Personal lines of credit, however, are more flexible than a credit card because you can draw the money with checks, or often in cash, rather than only making card purchases. This makes a personal line of credit a potentially useful financial tool for many people.
Advantages of a personal line of credit
- Lower interest rates and fees than credit card cash advances, which makes it a less expensive option for long-term borrowing.
- More flexible than a personal loan because it's a revolving credit account, so you can borrow money in small increments as you need it, rather than having to take a new loan each time.
- Personal lines of credit do not require collateral to secure the loan. That makes it ideal for people who do not own a home or don't want to put their home at risk through a home equity line of credit.
Disadvantages of a personal line of credit
- Interest rates on a personal line of credit are generally higher than on secured alternatives, like a home equity line of credit. In addition, interest payments are not tax deductible, while interest payments on a home equity line of credit can be claimed by many people as tax deductions.
- Monthly payment amounts can change each month, which can make it difficult to budget for the payments. Payment requirements may include all of the interest charges, which are based on a variable interest rate, plus a fixed percentage of the outstanding balance.
- A personal line of credit impacts your credit score, and it can have a strong negative impact if you are borrowing close to your credit limit.
- You need a strong credit history and proof of steady income to open a personal line of credit. Therefore, you probably need to think ahead and apply for the line of credit in advance of a crisis situation.
Is a personal line of credit right for you?
Before applying for a personal line of credit, take an honest look at your personal finances and consider your budget and spending habits. A personal line of credit has the potential to lead to undisciplined spending because there are no restrictions on when you draw the money and what you spend it on. However, in the right situation, a personal line of credit can be a useful financial tool.
A personal line of credit might be right for you if you are self-employed, work on commission, or otherwise have an uneven cash flow. It can help smooth out cash flow because you can borrow during months when you are not receiving much money, then make large repayments during months with a surplus. A personal line of credit can also be a good security net if you work in a volatile industry and want to have an emergency source of cash during times of unemployment.
A personal line of credit might not be right for you if you do not live on a balanced budget, and you are planning to make purchases that are beyond your means. You do not want to dig yourself into debt from which you cannot escape. Also, you might not be able to get a personal line of credit if you have average or poor credit history or you cannot show proof of steady employment.