How To Use a Personal Line of Credit: A Step-by-Step Guide
Managing your personal finances can often feel confusing — especially when you’re trying to figure out a new financial tool like a personal line of credit.
A personal line of credit (sometimes referred to as a PLOC or simply an LOC) is a flexible financial tool that can help you manage your cash flow and finance other expenses. It’s a source you can draw funds from as you need them. It can come in handy when unexpected expenses threaten to throw your budget off balance.
To use a line of credit effectively, it’s important to first understand how it works. Let’s walk through some things you need to know about securing and using a personal line of credit.
1. Determine Why You Need the Funds
Before making any major financial decisions, you should consider why you need the funds. A line of credit is a versatile financial tool. It allows you to borrow money up to a certain amount and as you repay, the funds become available to borrow again. You typically only pay interest on the amount you borrow.
A personal line of credit can be a good tool to have in case of emergency expenses, such as your car breaking down. Some of the other common uses of personal lines of credit include managing cash flow, paying for recurring expenses and financing ongoing projects such as home improvement projects.
It’s different from a personal installment loan. With a personal loan, you receive a lump sum of money up front and pay interest or fees on the whole amount. A personal term loan can be useful for large one-time expenses.
2. Choose the Lender and Line of Credit
If you’ve decided that a line of credit is right for you, you now have to decide which line of credit is right for you. A few things to consider when choosing a line of credit include the following.
The lender. Banks, credit unions and online lenders are some of the financial institutions that offer lines of credit. Different lenders will have different eligibility requirements, application processes, terms and more.
Credit limit. Look for a line of credit that offers the credit limit you need.
Interest rate. Your interest rates may be determined by your creditworthiness. A good credit score could help you get better rates, while a poor credit score could mean you’ll have to deal with higher interest rates. A lower interest rate can result in lower costs over time. You should also be on the lookout to see if it is a fixed interest rate or a variable interest rate.
Fees. Many personal lines of credit come with fees such as annual fees, maintenance fees or withdrawal fees. Be sure to read the contract carefully before signing.
Secured vs unsecured. Similarly to a secured loan, a secured line of credit is backed by collateral which the lender can seize and sell if you fail to repay. One example of a secured line of credit is a home equity line of credit (HELOC). An unsecured personal line of credit doesn’t require collateral. This could result in higher interest rates, but you don’t risk losing any pledged assets.
3. Submit an Application
After you’ve found the right personal line of credit, you’ll need to fill out an application. This can be done online or in person. You’ll need to provide some personal and financial information such as your Social Security number, proof of income and employment verification.
Depending on the lender you choose, the application process may take a longer amount of time. If you need the funds fast, you may want to choose an online lender that can process your application and get your funds to you fast.
4. Draw What You Need
Your credit limit is the amount of money you can borrow through a line of credit. You can draw a portion of the available credit, or you can withdraw it all. Keep in mind that maxing out a revolving credit line can raise your utilization ratio and impact your credit history. Because of this, it can be best to limit your draws to what you need and pay down your balance as soon as you can. Many experts recommend keeping your utilization ratio on revolving accounts below 30% to avoid potentially impacting your credit score.
5. Receive Your Money
Depending on the line of credit and the lender, you may have different methods for accessing your funds. Some common examples include:
- A card or a book of checks specifically tied to your line of credit which can be used to draw funds directly.
- Having the funds electronically deposited into your bank account.
These two methods help ensure that you can access your funds quickly after the line of credit is established.
6. Make Payments
After you’ve received your funds, you’ll typically have to repay that draw within a set repayment period. Be sure to read all the terms set by your lender. Typically, there will be a minimum payment, which can include a portion of the principal plus any interest charges. You can also often pay more than the minimum payment to bring your balance down quicker. This can free up your available credit and save you money on interest.
7. Draw More Funds as Needed
One great thing about lines of credit is that they’re a form of revolving credit. Unlike a traditional loan, which provides you with a lump sum, a personal line of credit operates more like a credit card in some ways. As long as you haven’t reached your credit limit, you’ll have funds available and as you pay your balance down, the funds will become available to borrow again.
How Do I Qualify for a Personal Line of Credit?
Every lender will have different qualification standards. You may need to meet any credit score requirements, have a stable income, an active checking account or potentially some form of collateral.
Banks and other traditional lenders often have stricter eligibility requirements. They will likely run a hard credit check and may require you to have an excellent credit history to qualify.
If you’re worried about qualifying for a personal line of credit, it may be beneficial to check out an alternative lender. Online lenders can be less strict than other lenders. They may run an alternative credit check that lets them examine your financial history as a whole, so they could be able to extend credit to those the banks can’t.
How Often Can I Draw From a Line of Credit?
With most lines of credit, you can draw funds up to your approved credit limit whenever you need them. This provides you with a reliable, reusable source of funds.
Here are a few things to consider when taking multiple draws:
Minimum draw amounts. Some lines of credit may have a rule around the minimum amount you can draw.
Repayment and re-borrowing. Some lenders may require you to pay down a portion of the principal before you can borrow again.
Draw periods. Many lines of credit have a lifespan — called a draw period. This is a set period of time during which you can make draws (for example,10 years). After the draw period is up, you’ll pay down the balance but won’t be able to draw funds anymore.
How Is Interest Charged on a Personal Line of Credit?
With a personal line of credit, you will typically only be charged interest on the amount that you draw, not your entire credit limit. That means, if you have a $10,000 credit limit but only draw $2,000, you only have to pay interest on that $2,000.
Are There Fees Associated With a Line of Credit?
Yes, many lines of credit also have some fees. Some of these fees include:
Origination fees. This fee covers the cost of processing your application.
Annual fees. Some lenders may charge an annual fee for maintaining your line of credit. This could also be called a maintenance fee, and it may be charged monthly instead of annually.
Transaction fees. Some lenders will charge a fee for each draw you make. This may also be called a cash advance fee.
Statement balance fees. Some lenders charge statement balance fees. These work similar to interest. For example you could be charged 10% each month on the outstanding amount you owe, sometimes represented as $10 per every $100 owed.
Late payment fees. If you miss your monthly payment, you could be charged a late or missed payment fee.
How Does a Line of Credit Affect my Credit History?
A line of credit can affect your credit history in a few different ways.
The application. If your lender runs a hard credit check when you apply, it may temporarily impact your credit history.
Credit utilization rate. A high utilization rate can impact your credit history, while a low utilization rate can help improve it in some circumstances.
Repayment. Repayment history is one of the most important factors that goes into calculating your FICO Score. Making payments on time and in full can help you build your credit history while missing or late payments can negatively impact your credit history.
DISCLAIMER: This content is for educational and information purposes only, and is not intended as financial, investment, or legal advice. NetCredit’s offerings may differ from the limited information included herein.