A personal line of credit is a type of credit account that allows you to access a predetermined amount of money for a fixed window of time. While the account is open, you can borrow this money to finance purchases as needed.
Personal line of credit is often used for unexpected expenses to cover short-term cash flow needs, but they can also be useful in a wide variety of other circumstances. This article will help you understand what a personal line of credit is.
How does a personal line of credit work?
When you open a personal line of credit, your issuer gives you the total amount of credit you can use, known as your credit limit. This means that you are free to use any amount of credit up to this limit during your line of credit’s draw period, which is the fixed window of time when your line of credit is available.
Unlike loans, where you must pay back the entire amount you’ve borrowed, personal lines of credit are a form of revolving debt. This means that even though you’re given a certain amount of credit to use, you only pay back the amount you end up borrowing to make purchases.
By and large, personal lines of credit are unsecured and require no collateral. Though this means you won’t put any of your assets at risk, it also means that you’ll generally need a better credit score to access a personal line of credit.
How do payments work for a personal line of credit?
Personal line of credit payments works similarly to credit card payments. For the amount that you borrow, you will have a due date by which you need to pay back that borrowed amount. If you don’t pay back the full amount borrowed by the due date, you will be charged interest on that outstanding balance.
As with credit cards, you also have minimum payments that you can make on your line of credit’s outstanding balance. However, it’s recommended that you try to make more than the minimum payment whenever possible to avoid any unnecessary interest charges.
With some personal lines of credit, you may be required to pay back the amount borrowed in full once a year. It’s also important to note that if you don’t make your payments on time, you may be charged late fees, and your credit score could be negatively impacted.
Make sure to check the terms of your lender’s agreement to understand the pay structure and what your requirements will be.
How is interest charged for a personal line of credit?
A personal line of credit typically has a variable APR, which means its interest rate can change over time. This rate is usually based on a market index, such as the prime rate.
Variable rate APRs tend to fluctuate with market conditions, which makes them more unpredictable, so make sure you understand how much a line of credit’s APR can change before applying.
How do you qualify for a personal line of credit?
The best way to qualify for a personal line of credit is to meet your lender’s standards for creditworthiness and income. This indicates that you’re unlikely to default on repayments, and it’ll make lenders more willing to work with you. Standards for creditworthiness and income will vary from lender to lender.
Once you’ve decided that you want to use a personal line of credit, the next step is submitting a formal application. The most common places to do this are banks, credit unions, and online lenders.
Benefits of a Personal Line of Credit
Personal lines of credit offer many advantages. Here are some of the key reasons people may want to obtain one:
Flexible Access to Funds
One upside to a personal line of credit compared to other types of credit is its flexibility. You can borrow against your credit limit in any amount and at any point during the draw period.
Remember that a personal line of credit is revolving debt, not installment debt. This means that although you do have to pay back anything you purchase, including interest charges, you don’t have to do so in a fixed installment amount.
Pay Interest Only on the Funds You Use
A personal line of credit comes with an interest rate, which is usually variable. But this rate only applies to purchases made instead of the entire loan. In other words, if you take out a personal line of credit and never use it for anything, you won’t owe any interest.
For example, if you’re given a $10,000 line of credit and you only use $2,000 of it, you’ll only have to make payments on the $2,000 you borrowed. You can also use the line of credit multiple times, as long as you don’t exceed the total amount of credit you’ve been given.
Other Usage Options for Funds
A personal line of credit can also be used to finance a purchase like a car, cover medical expenses, and refinance older debts. Any larger, one-time purchase could be easier to pay off with a personal line of credit than with a credit card.
Explore your credit options
Because personal lines of credit are typically extended to people with very good credit, they may not be within reach for everyone. If you find that you can’t get a personal line of credit, consider these alternatives.
Credit cards can be an excellent option for those wanting to access credit without the draw period that personal lines of credit have. When compared to personal lines of credit, credit cards tend to have higher interest rates and lower qualification requirements.
When you take out a personal loan, you receive a lump sum upfront and then pay it back in monthly installments. This is different from how a personal line of credit is structured, but a personal loan could be a better option if you need the entire lump sum right away.
HELOC (Home Equity Lines of Credit)
A home equity line of credit is a special variant of a personal line of credit, in which you can get funding using the equity in your home. A HELOC has a variable interest rate, and unlike a personal line of credit, it’s secured. This means that your home is put up as collateral as part of the loan. Be very aware of this fact as you consider whether to take out a HELOC.
Disclaimer: Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.