What Is a Personal Line of Credit?

A personal line of credit can be a useful financial tool when you need flexibility. Unlike a traditional loan that gives you a lump sum upfront, a line of credit allows you to borrow money as needed, up to a set limit. You can use it for everything from unexpected expenses to larger ongoing projects, then repay and borrow again as funds become available.

Many people compare it to a credit card because it offers revolving access to funds, but there are some important differences in how personal lines of credit work, how interest is charged, and how they’re typically used.

In this guide, we’ll break down how personal lines of credit work, common uses for personal line of credit accounts, and how to decide whether this type of borrowing makes sense for your financial situation. Along the way, we’ll also share insights from Valerie Figueroa, Consumer Lending Manager here at Amplify Credit Union, to help explain when a personal line of credit may be the right borrowing solution.

What is a personal line of credit?

A personal line of credit is a type of revolving loan that allows you to borrow money when you need it, rather than receiving all the funds at once. After you’re approved, your lender gives you a maximum borrowing limit. You can then withdraw money from that limit as needed and repay it over time.

“One of the biggest advantages is that you’re not paying interest on money that’s just sitting there,” Figueroa said. “You can draw what you need, repay it, and have those funds available again without taking out a brand-new loan every time.”

For example, if you’re approved for a $10,000 line of credit but only use $2,000, you’ll typically only pay interest on that $2,000 balance. As you repay the borrowed amount, those funds become available to use again.

Some personal lines of credit are unsecured, meaning they don’t require collateral. Others are secured by an asset, such as a savings account. Approval, credit limits, and interest rates are usually based on factors like your credit score, income, debt levels, and overall financial history.

Personal Line of Credit vs. Personal Loan

Personal lines of credit and personal loans both allow you to borrow money, but they work differently and are designed for different situations.

A personal loan gives you a lump sum upfront. You then repay that amount over a fixed period with predictable monthly payments. This can work well for one-time expenses where you already know the total cost, like consolidating debt or financing a major purchase.

A personal line of credit is more flexible. Instead of receiving all the money at once, you can borrow only what you need, when you need it. Your balance can go up or down over time, depending on how much you use and repay.

According to Figueroa, the decision often comes down to how predictable your expenses are. A personal loan may make more sense when you know exactly how much you’ll need, while a line of credit is often better suited for expenses that unfold over time or are harder to estimate.

For example, a personal loan may make more sense for a planned expense with a clear price tag. A personal line of credit may be more useful for expenses that happen gradually or are harder to predict, like home repairs, medical expenses, or ongoing projects.

Another important difference is repayment structure. Personal loans often come with fixed interest rates and set repayment schedules, while personal lines of credit commonly have variable rates and changing payment amounts based on your balance.

The right option depends on your financial goals, the type of expense you’re covering, and how much flexibility you need.

Common Uses for a Personal Line of Credit

One of the biggest advantages of a personal line of credit is flexibility. Because you can borrow only what you need and reuse funds as you repay them, this type of financing can work well for a variety of situations.

Some common uses for personal line of credit accounts include:

• Emergency expenses, such as unexpected car repairs or urgent home repairs
• Medical bills that may need to be paid over time
• Ongoing home improvement projects where costs may change as work progresses
• Temporary cash flow gaps between paychecks or major deposits
• Large planned purchases that you may not want to pay for all at once
• Backup funds for unexpected financial situations

A personal line of credit can be especially helpful when the exact cost of an expense is uncertain. Instead of borrowing a large lump sum upfront, you can access smaller amounts as needed and avoid paying interest on money you never use.

“Many people open a line of credit not because they expect an emergency, but because they want to be prepared if one happens,” Figueroa said. “Having access to funds before you need them can provide peace of mind when unexpected expenses come up.”

That said, it’s still important to borrow carefully. Since lines of credit can remain open and reusable, it can be easy to take on more debt than originally planned if spending isn’t managed closely.

Pros of a Personal Line of Credit

A personal line of credit can offer several advantages, especially for people who want flexibility when borrowing money.

Some of the biggest benefits include:

• Borrow only what you need: You don’t have to take a full lump sum upfront. This can help reduce unnecessary interest charges.
• Pay interest only on the amount you use: If you have a $10,000 credit limit but only borrow $2,000, interest is generally charged only on that $2,000 balance.
• Reusable access to funds: As you repay borrowed money, those funds typically become available to use again without reapplying.
• Helpful for unexpected expenses: A line of credit can provide quick access to emergency funds for things like medical bills, car repairs, or urgent home expenses.
• Potentially lower rates than some credit cards: Depending on your credit profile and lender, a personal line of credit may come with a lower interest rate than a traditional credit card.

Figueroa says one of the biggest misconceptions is that borrowers need to use the full credit line once they’re approved. In reality, many people appreciate having access to funds without drawing on them until a legitimate need arises.

Drawbacks of a Personal Line of Credit

Like any borrowing option, a personal line of credit also comes with some considerations. Understanding the potential downsides can help you decide whether it fits your financial needs and borrowing habits.

Some potential drawbacks include:

• Variable interest rates: Many personal lines of credit have rates that can increase or decrease over time. If rates rise, borrowing costs may increase as well.
• Easy access can lead to overspending: Because funds remain available to use, it can be tempting to borrow more than originally planned.
• Missed payments can affect your credit: Late or missed payments may negatively impact your credit score and could make future borrowing more difficult.
• Fees may apply: Depending on the lender, there could be annual fees, maintenance fees, withdrawal fees, or other costs tied to the account.
• Approval requirements can be stricter: Personal lines of credit often require good credit and stable income to qualify for the best rates and terms.

None of these drawbacks automatically make a personal line of credit a bad choice. As Figueroa says, “Just because the money is available doesn’t mean you have to use it. Treating a line of credit as a financial tool instead of extra spending money can help you avoid unnecessary debt.”

How to Decide If a Personal Line of Credit Makes Sense

A personal line of credit can be helpful in the right situation, but it is not the best fit for every borrowing need. Before applying, it’s worth thinking about how you plan to use the funds and whether the flexibility of a revolving account would actually benefit you. Figueroa recommends thinking beyond today’s expenses. She encourages borrowers to consider how comfortably the payments would fit into their budget if they needed to draw on the account unexpectedly.

This article was first published on July 22, 2020.