Personal Lines of Credit

before you start

Credit is everywhere, isn’t it? Whether it’s your phone bill, groceries, or buying that couch you’ve had your eye on, there’s often an option to put it on credit. But not all credit is created equal, and with so many options, it’s easy to feel overwhelmed.

You already learned about credit cards and how to use them wisely. Building on that, in this lesson, we will cover one specific type of credit: the personal line of credit.

If used smartly, it can be a handy financial tool for managing both planned and unexpected expenses. Don’t worry; we’ll get into the nitty-gritty of everything in this lesson.

1. What Is a Personal Line of Credit?

Picture a safety net you can tap into when you need extra money without the commitment of a loan or the high interest of a credit card. Sounds pretty good, right? A personal line of credit works just like that. It’s a revolving credit account, meaning you can borrow up to a certain limit, pay it back, and borrow again as you need.

Let’s look at three of the major benefits of a personal line of credit:

1. Revolving credit account: Think of a personal line of credit like a water pitcher at a party. Imagine you’re hosting, and you want your guests to have access to water all night. You pour a glass for someone and then refill the pitcher. This is similar to how a personal line of credit works: If your limit is $5,000, you can borrow any amount up to that limit, pay it back, and then borrow again when you need it. So, if you use $1,000 to cover a car repair, pay it off in a few months, and then need $500 for a quick home repair, it’s all available as long as you stay under the $5,000 limit. Your available credit literally revolves.
2. Interest only on what you borrow: With a personal line of credit, interest only kicks in on what you actually use, not the full limit. For instance, let’s say your credit line is $10,000, but you only need $1,000 to cover a medical bill. You’ll only pay interest on that $1,000 until you pay it back—not on the whole $10,000. This can help you avoid paying interest on money you didn’t even need, which is a big difference from traditional loans that charge interest on the entire amount.
3. Monthly repayment: Just like with a credit card, you’ll have a minimum payment due each month. For example, if you borrowed $1,000, your minimum payment might be around $50, covering the interest plus a small part of the principal. You can pay more than the minimum if you want to reduce your balance faster and save on interest. So, if you’re able to put down an extra $100 each month, you’ll pay off the balance quicker and cut down on the interest costs.

Now that you know the basics, let’s see what makes a personal line of credit different from other types of consumer credit. With so many options—credit cards, loans, home equity lines—it can get confusing. Which one should you choose? Understanding the unique benefits of a personal line of credit can help you decide if it’s the right choice for you.

Here’s how a personal line of credit compares to other popular consumer credit options.

Credit Type	Description	Ideal For ...
Personal loan	One-time fixed amount you pay off over time in regular monthly payments	A big purchase like a car
Credit card	A revolving line of credit with higher interest rates that you often use daily for purchases	Everyday expenses like groceries, gas, eating out, and entertainment
Home equity line of credit (HELOC)	A revolving credit line that is backed by the equity in your home (we’ll explore HELOCs in depth in an upcoming topic).	Home renovations and large expenses
Personal line of credit	A revolving credit line that is flexible and typically has a lower interest rate than a credit card	Emergencies and irregular expenses

big idea

Think of a personal line of credit as a financial lifeline, one you can dip into as needed and repay at your own pace. It starts with an application, where the bank sets your credit limit based on your financial profile (things like your credit score, income, and debt). From there, it’s up to you—borrow only what you need and repay as you wish. Unlike a regular loan, which is pretty rigid, a personal line of credit adjusts to fit what you need. Next, let’s look at an example of how a personal line of credit works step by step, from applying to understanding those all-important interest rates.

terms to know

Personal Line of Credit

A flexible loan that lets you borrow up to a set limit, repay it, and borrow again as needed. You only pay interest on what you actually use.

Revolving Credit Account

A type of credit that lets you borrow, repay, and borrow again up to a credit limit. Examples are credit cards and personal lines of credit.

Home Equity Line of Credit (HELOC)

A loan that lets you borrow against the equity in your home, with a set credit limit you can draw from as needed. Your home is used as collateral for this loan.

1a. How Do Personal Lines of Credit Work?

A personal line of credit works a lot like having a financial safety net that’s ready when you need it, whether it’s for unexpected expenses or planned projects. To make it simple, let’s walk through five (5) steps—how to apply, what happens once you’re approved, and how to make the most of it so you’re always prepared.

1. Application and Approval

Banks and credit unions offer personal lines of credit, but before they give the green light, they need to make sure you’re likely to pay back what you borrow. So, they’ll check things like your credit score, income, and current debt. Think of it like the bank asking, “Can you handle this responsibly?” If everything looks good, you’re approved, and you get a set limit.

EXAMPLE

You’ve been approved by your bank for a $5,000 personal line of credit. This means you have access to borrow up to $5,000 whenever you need it. You don’t need to borrow the full amount all at once. You can borrow an amount now, some later, pay some back, and borrow again. This truly is a flexible type of loan.

2. Credit Limit and Terms

Once approved, you get a set credit limit and terms. Your credit limit is the most you can borrow at any time. Your terms include the interest rate you’ll pay (often based on your credit score) and any specific rules the lender has.

reflect

The higher your credit score is, the lower your interest rate will be on your personal line of credit and vice versa.

3. Borrowing and Repayment

Now, let’s say you need to make a big purchase or cover an unexpected bill. With a line of credit, you can borrow only what you need from your total limit and start paying interest on that amount. You don’t need to use the whole amount, and you only pay for what you actually use. Each month, you make a minimum payment that covers some interest and principal.

EXAMPLE

You borrow $1,000 to cover a car repair. Now, you’re paying interest just on that $1,000, not the full $5,000 limit. This month, your minimum payment is $30, covering interest and a small portion of the original $1,000 borrowed. However, you can pay more than the minimum to reduce the balance faster.

4. Interest Rates

Personal lines of credit typically have variable interest rates, meaning the interest rate can go up or down over time based on the market. Think of it like gas prices—they can change depending on supply, demand, and other factors in the economy that you’ve learned about. With a variable interest rate, if the economy is doing well, rates might go up, which increases the interest on your borrowed amount. But if the economy slows down, rates might drop, and you could end up paying less interest. It’s tied to market trends, so you’ll want to keep an eye on any rate changes to manage your payments. This makes it important to watch the rate since it affects how much you pay in interest.

EXAMPLE

When you first take out the credit line, the rate is 10%, but a year later, it jumps to 12%. If you still owe money, this rate change means your monthly payments might go up a bit to cover the higher interest. Your rate could also drop, meaning your monthly payments might go down a bit due to lower interest.

learn more

You’re probably thinking, “OK, so how do I keep up on any rate changes easily?” That’s a great question. Although you won’t be tested on this information, it’s important to know where to go to check any potential interest rate changes.

Click on the “+” to expand to see a few simple ways to check on interest rate changes:

• Check Your Bank Statements: Many banks list your current interest rate on your monthly statement, so reviewing these can give you a quick update.
• Use Online Banking or App Alerts: Most banks have online banking platforms or apps where you can view your interest rate. Some even let you set up alerts if there’s a change, so you’re notified right away.
• Contact Your Lender Directly: If you’re unsure about your rate, a quick call or message to your bank or credit union can give you the latest info.
• Follow Economic News: Changes in the economy, like decisions made by the Federal Reserve, can influence rates. Keeping an eye on major economic news can give you a heads-up on potential increases or decreases in interest rates. You learned all about the Federal Reserve and the essential economic indicators previously.

These simple steps can help you stay in the loop on any changes and give you more control over managing your line of credit.

5. Set or Ongoing Term

Some personal lines of credit have a set term, after which you need to renew them if you want to keep the credit lines open. Others are ongoing as long as you keep making payments and stay within your limit.

Choosing between a loan that has a set term and needs a renewal or an ongoing one really depends on your needs for the loan. Here are a few things to think about when you’re deciding which option would be best for you.

• If you only need a line of credit for a specific period—like a year or two to cover some home renovations or as a backup for an irregular income—a set-term line of credit might work well. You’ll know exactly when it’s ending and can plan your borrowing around that timeline.
• If you want the peace of mind of having funds available at any time, even after a few years, an ongoing line of credit might be better. With this type, you can keep using it without worrying about renewals as long as you’re staying within your limit and making payments. This option is great for covering unexpected costs.
• For set-term credit lines, renewal isn’t always guaranteed. Banks often review your financial profile (credit score, income, and debt) before renewing. If your income might change or you don’t want to worry about reapplying, an ongoing line might be more convenient.
• Your bank can explain the terms of each option and how they would fit your needs. Some lines of credit even have both options available, so you can choose the one that aligns with your financial situation.

hint

Fixed-time credit lines usually have lower interest rates than ongoing credit lines because they’re less risky for lenders. If you’re looking for a lower rate, a fixed-time option might be your best bet.

Now that you know how a personal line of credit works, you might be wondering, “Can anyone just go and get one?” The answer depends on a few key factors that lenders look for. Next, let’s dive into what it takes to qualify so you know exactly what to expect when applying.

terms to know

Variable Interest Rates

Interest rates that can change over time based on market conditions, affecting how much you pay.

Set-Term Line of Credit

A line of credit with a fixed period; you need to renew it if you want to keep it open after the term ends.

Ongoing Line of Credit

A line of credit without a fixed end date that remains open as long as you make payments and stay within the credit limit.

1b. Who Can Get a Personal Line of Credit?

Not everyone can get a personal line of credit—lenders need to feel confident that you can handle borrowing responsibly and pay your loan back on time. Think of it like this: They’re essentially taking a bet on you and want some reassurance that you’ll pay it back on time and keep things manageable. So, before approving your application, they’ll check a few key factors to make sure you’re a low-risk borrower. Here’s what they’re looking for to say “yes” to your application.

• You already know that your credit score is essentially your financial reputation. Lenders want to see that you’ve got a good track record with credit, usually around 650 or higher. If your score is strong, it shows that you’re likely to pay back what you borrowed.
• Imagine lending someone money without knowing how much they make—risky, right? Lenders feel the same way. They want proof you have a stable income so you’ll be able to make those monthly payments without a hitch. This means whether you get paid every month regularly and have a track record of a consistent job.
• Recall the debt-to-income (DTI) ratio. Ideally, you want a low DTI (below 35%) so lenders can feel confident you’re not biting off more than you can chew with extra credit. You’ll be a pro at DTI ratios in a future lesson, so for now, just understand the concept.
• Remember the five factors that make up a good credit score that we’ve covered? Lenders want to know that you have a good history with credit. They’re looking to see things like consistent, on-time payments and a balanced mix of credit accounts (e.g., credit cards and car loans). If you’re new to credit or have a history of missed payments, they may worry about lending to you.

So, if you don’t meet all these criteria, you may get a lower credit limit or a higher interest rate, or your application might be denied. But don’t worry—if you’re not there yet, improving your credit score, paying down debt, or boosting your income can all help you qualify in the future.

Now that you know how a personal line of credit functions, you might be wondering, “When should I actually use this?” After all, having access to credit doesn’t mean you should use it for everything. In this next section, we’ll explore the times when a personal line of credit can make life a lot easier and help you handle everything from unexpected bills to planned expenses.

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2. Uses of a Personal Line of Credit

Knowing when to use a personal line of credit is just as important as knowing how it works. Think of it like a toolbox: You wouldn’t reach for every tool for every job. Sometimes, a credit card or savings account might be a better choice, but other times a personal line of credit is exactly what you need. Here, we’ll go over five (5) ideal scenarios where this type of credit can give you a financial boost without creating unnecessary debt. Whether it’s for emergencies or covering a temporary cash flow shortage, you’ll see how it can serve as a smart solution.

1. Covering Unexpected Emergencies

Life has a way of surprising us with sudden expenses—a car repair, a medical bill, or a broken appliance can hit when we least expect it. When this happens, it’s rarely planned for and usually quite expensive. A personal line of credit can act as a financial cushion in these moments, helping provide some much-needed money to cover the expense.

EXAMPLE

Imagine your car suddenly breaks down, and the repairs will cost $800. You don’t want to dip into your emergency savings or use a high-interest credit card, so you use your personal line of credit. You borrow just the $800 you need, and then you can focus on paying it back over time, making it a manageable solution for an unexpected cost. Because your line of credit has a lower interest rate than your credit card, it’s a smarter financial decision to use your personal line of credit.

2. Covering a Temporary Cash Flow Shortage

For freelancers, gig workers, or small business owners with irregular income, cash flow shortages are common from month to month. A personal line of credit can help you cover necessary expenses during a slow period without interrupting your current lifestyle or having to dip into your savings.

EXAMPLE

Say you’re a freelancer waiting on a big payment from a client, but your bills are due now. Instead of stressing or making late payments, you borrow $1,000 from your line of credit to cover your expenses. Once the client payment comes in, you can repay the line of credit and get back to normal. This way, the line of credit serves as a helpful tool for you to manage your expenses without going into debt.

3. Consolidating High-Interest Debt

If you have multiple high-interest debts—like credit card balances—a personal line of credit can sometimes be used to consolidate them into one, often with a lower interest rate. This can make the debt more manageable and reduce the overall interest you pay. Check out the example below to bring this concept of consolidating to life.

EXAMPLE

Imagine you have $3,000 spread across three credit cards, each with an interest rate of around 20%. Instead of juggling three minimum payments, you use a personal line of credit with a 10% interest rate to pay off those cards. Now, you have a single monthly payment with a lower interest rate, which makes it easier to budget and helps you pay off the debt faster. This is great news for your financial plan.

4. Making a Large Purchase With a Repayment Plan

Sometimes, you need to make a big purchase but don’t want to put it all on a credit card, especially if you can’t pay it off quickly. With a personal line of credit, you can borrow only what you need, and you’ll typically have a lower interest rate plus a flexible repayment plan. This is a huge benefit of a personal line of credit and why it usually is a smarter choice than a credit card with a high interest rate.

EXAMPLE

You’re planning to upgrade your home office with a new desk, chair, and computer. The total cost is around $1,500. You could use your credit card, but you’d prefer to keep your balance low. Instead, you borrow $1,500 from your line of credit and set up a plan to pay it off over the next few months. This way, you’re not maxing out your credit card, and you have a clear plan to pay it back without high interest.

5. Home Improvement Projects

A personal line of credit is great for smaller home improvement projects that don’t require a full home equity loan or HELOC. As we discussed before, a HELOC lets you borrow money against the equity you’ve built in your home. Like a credit card, it gives you a set limit, and you only pay interest on what you borrow. It’s often used for home improvements or large expenses, but it’s secured by your home, so missed payments could put your house at risk. It’s a good fit for moderate expenses that add value to your home. We’ll cover everything you need to know about HELOCs in an upcoming lesson; for now, just understand that personal lines of credit are a better choice for smaller home projects and HELOCs are better for larger and more expensive projects.

EXAMPLE

Let’s say you want to renovate your bathroom, and the total cost is about $4,000. A personal line of credit lets you borrow just what you need without having to use your home as collateral, which would be required for a HELOC. You withdraw $4,000 from your line of credit and make monthly payments to pay it back. Using a personal line of credit allows you to upgrade your home with a brand-new magazine-worthy bathroom without a long-term loan or using all your savings.

big idea

Remember, a personal line of credit can be a real game changer, giving you the freedom and flexibility to tackle unexpected expenses or fund important projects without stress. The trick is to use a personal line of credit thoughtfully—think of it as a financial backup, not a free pass to spend. When used wisely, a personal line of credit can help you stay in control of your finances and make the most of any situations that might arise.