12 Pros and Cons of Getting a Personal Line of Credit
When used strategically, a personal line of credit can add flexibility and convenience to your personal finances. A line of credit can help with many financial needs, such as home improvement projects, debt consolidation and unexpected expenses. However, there are potential downsides to consider.
We’ll go through the benefits and drawbacks of a personal line of credit, and provide insight into how it differs from similar financial products.
Pros of a Line of Credit
Flexibility. A personal line of credit provides you with a predetermined amount of money available for borrowing, but the choice of when and how much to borrow is entirely up to you. You can access funds up to your credit limit through a draw period, which is ideal for an expense like a home improvement project, which requires payments over a period of time.
Basically, a line of credit allows you to keep funds on hand to use as needed, when needed.
Revolving credit. A line of credit is typically a form of revolving credit, acting like a financial pool that refills as you repay the borrowed amount. This means you can borrow from it repeatedly, provided you haven’t reached your credit limit. It’s a continuous source of funds, assuming you remain in good standing with the lender.
Only pay interest on what you borrow. Unlike a traditional loan, where you’re charged interest on the full amount from the beginning, a line of credit only incurs interest on the amount you’ve actually borrowed. This can be particularly cost-effective if you’re unsure about how much money you’ll need.
Get funds fast. Depending on your lender, funds can be provided quickly after a draw is made — sometimes as soon as the same day.
Potentially higher credit limit than credit cards. A line of credit can offer a higher credit limit than most credit cards, especially if you’re opting for a secured line of credit. However, your credit history may affect the credit limit on your line of credit.
No collateral. Personal lines of credit are often unsecured, which means they don’t need collateral. With an unsecured personal line of credit, you don’t have to promise something valuable, like your house or car, to get credit.
Borrowers with bad credit may be approved. You may be able to get a line of credit if you have bad credit. However, the line may come with higher interest rates or may require a co-signer or collateral.
Cons of a Line of Credit
Inconsistent payment amounts. With a line of credit, payments are calculated based on how much of the available funds are withdrawn. As a result, your repayments on a personal line of credit may vary from month to month. In contrast, personal installment loans can provide predictability with consistent payment amounts.
Fees. Some lines of credit come with fees, such as annual fees, origination fees, maintenance fees or transaction fees. It’s important to understand these costs, as they can add up over time.
Risk of overspending. Because a line of credit is so flexible, it’s easy to fall into the bad habit of borrowing more than you can afford to repay. This can eventually lead to a cycle of debt.
No grace period. Lines of credit start accumulating interest immediately. Credit cards give you a grace period, usually 30 days.
Potentially lower credit limit than installment loans. Another downside to a line of credit is that their credit limits may be lower than funds from an installment loan. Depending on your financial needs, the line of credit’s flexibility may be worth its lower credit limit.
How Do You Get a Line of Credit?
Lines of credit are available through most financial institutions, including traditional banks, credit unions and online lenders.
Qualifying for a personal line of credit typically involves a credit check and an assessment of your financial history. During the application process, lenders will examine your credit score, checking account status and overall creditworthiness. Those with good credit or excellent credit are likely to secure more favorable terms, such as higher amounts of available credit and lower interest rates.
Can You Get a Line of Credit with Bad Credit?
Yes, it is possible to get a line of credit with a low credit score. However, it often comes with higher interest rates or may require a co-signer or collateral. Lenders take on more risk with lower credit scores, which influences the terms they offer.
Another option is a secured line of credit, which requires collateral. Collateral could include savings account funds or other assets for overdraft protection.
A common type of secured credit line is a home equity line of credit (HELOC). HELOCs may offer lower interest rates because they’re secured by your home’s equity.
How Is a Line of Credit Different from a Credit Card?
Both offer revolving credit, which means you can borrow against your credit limit, repay and borrow again. However, personal lines of credit and credit cards have a number of differences. Lines of credit typically come with lower interest rates than credit cards, making them more cost-effective over time. Plus, credit cards often charge higher fees for cash advances.
How Is a Line of Credit Different from a Loan?
Compared to many types of loans, a line of credit offers withdrawal flexibility, rather than receiving a fixed amount up front.
Loans require you to start repaying a lump sum immediately with interest, while a line of credit allows you to make minimum payments on the credit you’ve used.
Most loan terms outline a fixed repayment schedule with a set interest rate. A line of credit, on the other hand, offers a flexible borrowing limit that you can tap into as needed, paying interest only on the amount you use. Additionally, unlike home equity loans or student loans, a line of credit is not tied to a specific use or type of expense.
The Bottom Line
A personal line of credit can be a helpful tool for anyone looking to manage their personal finance with agility. Whether for debt consolidation, renovations, or as a safeguard against unexpected expenses, it offers a flexible and often cost-effective way to borrow money.
While the advantages are clear, it’s important to acknowledge the risks. Higher interest rates than those of secured loans, the possibility of overspending and varying monthly payments can make managing a line of credit challenging for those with poor credit or less discipline in personal finance.
It’s important to remember that, like any type of credit, a personal line of credit should be used responsibly and with a clear understanding of the terms and conditions set by the issuer.
DISCLAIMER: This content is for informational purposes only, and is not intended as financial, investment or legal advice.