A personal line of credit is very similar to a credit card. A lender will check your credit score, verify your income and issue you a credit line for a certain amount. With a line of credit, you can access the funds when you need them as long as you have an available balance.
How Does a Line of Credit Work?
If you have a line of credit (LOC) with a $25,000 limit, you can use a part or all of that amount at any time during your draw period. Unlike a loan, you don’t make regular payments unless you have an outstanding balance.
For example, if you spend $5,000 on your $25,000 limit you will make payments plus interest on the $5,000 balance until you pay it off. You will also be responsible for any annual fees or other maintenance charges, which may be assessed monthly. It’s important to know that these terms can vary from bank to bank and should be clearly listed in your credit application.
Some lines of credit come with a debit card and checkbook, which makes it easy to use the credit or take out cash. There may be extra fees associated with taking out cash on a credit line, rather than paying a merchant directly with a credit card or check.
Three Types You Should Know
- Personal: credit available to consumers, based on income and creditworthiness
- Home Equity: available to homeowners who use their home as collateral
- Business: issued to a business, can be secured or unsecured
Secured vs. Unsecured Credit Line
Credit lines can be secured or unsecured. By far the most popular secured lines of credit are home equity lines of credit (HELOC). In a HELOC the home is used as collateral for credit equal to or lesser than the value of the home or the amount of equity the homeowner has in the property.
A personal line of credit (PLOC) is typically unsecured and your limit and interest rate will be based on your credit score and proof of income.
- A secured line requires collateral, such as a home or a car.
- An unsecured line is not guaranteed by a material asset.
- Unsecured credit usually means higher interest rates.
Comparing a Line of Credit with a Personal Loan
The main difference between a line of credit and a personal loan is how the money is received and repaid by the borrower. A personal loan is a lump-sum payment, while a line of credit is a revolving loan that allows the borrower to draw, repay and redraw money up to the maximum amount.
Line of Credit
- Borrower draws, pays and redraws on the line of credit up to the maximum amount of the line.
- The loan can be open-ended, without an end date, or have a draw period.
- Payments required as needed on the amount of credit used plus interest.
- Draw funds at the bank, or by using a credit card, debit card, or checkbook.
- Usually have a variable interest rate
- Generally have higher interest rates than personal loans.
- Generally lower minimum monthly payments than personal loans.
- The loan is received as a lump-sum payout.
- The loan has fixed repayment term (e.g. the loan must be repaid in 5 years)
- Regular monthly payments required on total loan value plus interest.
- Loan amount deposited into the borrower’s bank account.
- Usually have a fixed interest rate
- Generally have lower interest rates than a line of credit.
- Generally higher minimum monthly payments than a line of credit.
Common Uses For a Credit Line
You can take out a credit line for yourself or your business to cover expenses of any size. A LOC gives you more freedom and spending flexibility than a traditional loan. Here are some common uses:
- Stabilize irregular Income (e.g. independent contractors)
- Funding a project or event (e.g. home improvement)
- Emergency or other unexpected expenses
- Prevent overdraft or late fees
- Pay for medical bills
- Funding a business venture
Typical Rates for Unsecured Line of Credit Loan
This summary of typical rates, fees and terms is based on a review of unsecured personal credit lines from a variety of lenders. Terms vary by lender and will be unique to each lender and borrower.
Typical Rates, Fees and Terms for Unsecured Personal Line of Credit Loans
- Average Interest Rates - Variable (based on Prime Rate), generally 9.30% - 17.55%
- Term Range - 6 months - 5 years or open-ended
- Credit Limit - $1,000 - $100,000
- Repayment - Monthly when there is a balance
- Credit Score Requirement - 660 or higher
- Typical Fees:
- Maintenance fee (annual): $25 to $50
- Late fee: variable, $30 is typical
- Returned payment fee: variable, $25 to $40
Does a Line of Credit Affect Your Credit Score?
Yes, it can. Anytime a lender does a hard inquiry on your credit, this will be noted on your report and could impact your score. Additionally, if drawing on the LOC takes your debt to income ratio (DTI) above 43% your score could be affected. Lastly, if you make late payments on your credit or default on the borrowed money, your score will go down.
4 Ways a Credit Line Could Affect Your Credit Score
- A hard inquiry is made when you apply
- Drawing on your credit line increases your DTI
- Late payments are reported to the credit bureaus
- An unresolved line of credit in collections will hurt your score for 7 years
Managing Unpaid Line of Credit Debt
If you have multiple lines of credit and have fallen behind on your payments, you may want to consider a debt relief program. Debt specialists at Accredited Debt Relief can answer your questions in a free consultation. Contact us for more information.