What is a Personal Line of Credit?
A personal line of credit is simply a line of credit awarded to an individual as opposed to an entity. For those who do not yet know, a line of credit is a revolving cash loan lent by banks or other financial institutions wherein the recipient can withdraw funds, up to the preset limit, pay down balances, and only ever owe interest on the actual money withdrawn, as opposed to the total sum of the line of credit.
Limits and rates on credit lines are determined by the applicant’s revenue/income, credit score, and the like, upon applying, although a limit increase can be requested at a later time. Lines of credit can also be both secured and unsecured, but more on that below.
A personal line of credit is an attractive option for many individuals looking to pay for a one-off project or life event, finance an investment, or stabilize an irregular income, as interest rates on lines of credit tend to be lower than those on credit cards, the popular alternative.
When applying, you can expect your lending institution of choice to review your income, credit score, and credit history in determining both the interest rate and limit of your line of credit. The interest rate on your line of credit will be calculated by adding a margin, determined by your perceived creditworthiness, to the prime rate of the lending institution in question. It’s important to note that, as the prime rate of your lending institution changes over time, so will the overall interest rate on your line of credit.
It’s also worth noting that there is a world of difference between the interest rates available for secured vs unsecured lines of credit. A secured line of credit is one that is backed by collateral put forth by the applicant and is thus less risky, thereby making significantly lower rates palatable to the lending institution in question.
When speaking of credit requirements, there is again a big gulf between secured and unsecured lines of credit. Secured credit lines, being backed by significant collateral, will naturally have less stringent requirements as to the health of an applicant’s credit. Unsecured credit lines, in contrast, will require some degree of creditworthiness to be acceptable to a traditional lending institution.
The ideal applicant for an unsecured personal line of credit would have an adequate, regular income for honoring obligatory minimum monthly payments, and would have a credit score thought to be “prime” by the lending institution, a definition of range that changes institution to institution but that usually falls somewhere around the top quarter of achievable credit scores.
For Bad Credit
Individuals looking to apply for a personal line of credit who have bad credit aren’t totally out of luck, though options definitely are limited and less favorable than they would be for someone with healthier credit.
For one, an individual with bad credit can greatly increase their odds of being granted a line of credit if it is secured, or backed by collateral put forth by the applicant. Similarly, major lending institutions might be more amenable to granting the line of credit to an individual with bad credit if the application is made jointly with a co-signer with a higher credit score. Finally, a credit union, with its cooperative corporate structure and community focus, might be more willing to make an exception for someone with bad credit but an otherwise trustworthy reputation in extending a line of credit.
There is also a host of lenders who, for various reasons, are willing to offer lines of credit with no credit checks. This lending practice is oftentimes predatory and is illegal in several states for being so, but there are a few reputable lending institutions and third-party brokers who truly do have their lendee’s best interests at heart. Still, even with the most understanding of lenders, offering unsecured personal lines of credit offered with no credit check is only viable as a business if the terms of the credit line are unfavorable to the extreme – abundant fees, astronomical interest rates, and the like are to be expected. If you intend to apply for an unsecured personal line of credit and will not be opting for a credit check, be wary of predatory lenders, and be aware that rates won’t be favorable.
Personal Line of Credit vs Personal Loan
A personal line of credit is similar to a personal loan in many ways. In granting either, a lending institution will examine your income, credit score, and credit history, in determining eligibility. Both charge interest on borrowed funds, and both, when made use of, will affect your credit score. Both can be either secured or unsecured, and both have a set time frame wherein the withdrawn funds will need to be repaid in full, plus interest.
A personal line of credit distinguishes itself from a loan in that, unlike loans, which tend to be highly specified as to their intended use (mortgage for purchasing listed property, auto-loans for buying a car, etc.), lines of credit are more open-ended, their funds being usable on a non-discretionary basis. Also, lines of credit can be paid down similar to credit cards, in that, as long as minimum monthly payments are met, balances can be met on the recipient’s schedule. Loans, in contrast, often feature rigid, scheduled payment structures within their agreements.
Secured vs Unsecured
A secured line of credit is one wherein the applicant has put forth some collateral to back the loan, such as their home or other property. Secured lines of credit are, by their nature, less risky for a lending institution to grant, and thus tend to make more favorable interest rates available to applicants. A popular secured personal line of credit is a Home Equity Line of Credit or HELOC, wherein the applicant puts forth the equity in their home as collateral.
An unsecured line of credit is one wherein there is no collateral put forth by the applicant. They are inherently more risky for lenders and thus have higher interest rates.
Stated-Income Personal Line of Credit
Although rarer following the Great Recession and subsequent Dodd-Frank Wall Street Reform and Consumer Protection Act, stated income lines of credit, wherein an applicant, as part of the financial verification process, is asked to state their income and is taken at their word without any documentation, are still offered and may be a good option, depending on your particular circumstances.
Although stated income lines of credit are ostensibly designed for individuals with difficult-to-prove incomes, or for individuals whose debt-to-income ratios are below prime (someone, for instance, who owns several houses may have adequate income to meet payments despite also having several mortgages to their name), they are often applied for fraudulently by individuals who simply lie about the true value of their income, and are thus known in some circles as liars loans.
If you're unsure whether a line of credit is the right option for you, there's tons of info online offering advice on how they work, or alternative borrowing options. Ultimately, doing your research and looing into all your options is the best way to make sure you're making the best move for your finances.