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When you need to borrow money, you may think to borrow a personal loan or get a credit card or home equity line of credit (HELOC). But there’s a lesser-known financing option you may not want to overlook: a personal line of credit.
Don’t confuse a personal line of credit with a credit card. It isn’t a piece of plastic you can whip out and swipe at the grocery store. Instead, it’s a line of credit from which you can draw cash that’s often offered by banks and credit unions to existing customers who meet certain requirements. Here’s what you need to know about this financial product.
What is a personal line of credit?
A personal line of credit is a loan you can use and pay back as needed. The terms of the product can vary from one lender to another.
Interest rates: In most cases, personal lines of credit come with variable interest rates. But they can come with a fixed interest rate. You can find rates starting at around 8%, but they may be as high as 20% or more.
Costs: Aside from the interest rate, personal lines of credit may have other costs. Take care to read through the fine print of the terms for these potential fees:
- Application fees: This is the cost to apply for the account. Many financial institutions don’t charge for applications, but it’s a good idea to double-check.
- Annual fees: This is a fee charged each year you have the account. For example, Wells Fargo and TD Bank charge $25 annually for personal lines of credit. Some banks will waive fees as long as you have an open bank account. Check the terms for details.
- Cash advance fees: This fee may be charged each time you withdraw money from your credit line. Many financial institutions don’t charge this fee.
Credit limits: Credit limits for personal lines of credit can vary. Credit limits can be a few thousand dollars to well over $1 million.
Unsecured vs. secured personal lines of credit: What’s the difference?
As you research personal lines of credit, you’ll find that they can come secured or unsecured. An unsecured personal line of credit doesn’t require collateral. A secured personal line of credit, on the other hand, requires collateral and may be backed by the balance in a savings account, certificate of deposit or investment account.
Collateral reduces the risk for the financial institution lending you money. As a result, secured personal lines of credit generally have lower interest rates.
But a secured line of credit comes with a higher risk to you. If you fail to repay your debt, you could lose your collateral. And you may not have access to the collateral you use to secure the credit line until the debt is repaid.
Where you can find a personal line of credit
Personal lines of credit are marketed less widely than other products, but there are several available from small and large banks and credit unions. The first place to shop for a personal line of credit is the financial institution you use for banking.
Some banks, such as Citibank, only take applications from existing customers. Others, such as Santander Bank and TD Bank, will waive fees for their customers.
The requirements to qualify for a personal line of credit vary from one lender to the next. For a Citibank personal line of credit, you need to have a deposit account with a balance over $500 and a, Citibank mortgage or Citi credit card that’s at least 3 months old.
Some financial institutions may not require you to have a checking account to qualify for a personal line of the credit. Be sure to comparison shop to find a personal line of credit that makes sense for you.
How a personal line of credit works
Obtaining a personal line of credit starts with the application.
The creditor may check your debt-to-income (DTI) ratio, credit score and credit history. You may have to turn in pay stubs, W-2s, tax documents and other supporting information for the application. If you already have accounts with the financial institution, it may also dig into the history to see if you have any overdrafts or other signs of misuse that could impact their decision.
Once approved, you get the terms of the agreement to sign at a local branch or online. You will likely get access to the funds within a few days.
To use the credit line, you may be able to:
- Transfer cash from the credit line into a bank account
- Get an advance from a physical bank location
- Write a credit check to yourself or someone else
Some personal lines of credit give you a draw period that lasts a couple of years. During this draw period, you can draw up to the credit limit. After the draw period, the repayment term begins, and you need to pay the money back.
A monthly minimum payment is typically required. Wells Fargo’s minimum payment for an unsecured personal credit line is 1%. The Wells Fargo CD or savings secured personal line of credit has a minimum payment that’s 1/120th of your principal balance. Additional fees may apply.
Some personal lines of credit offer an interest-only payment option. With this repayment option, you’re only required to pay the interest incurred on your credit balance for a certain period. Be careful about getting into the low-cost, interest-only payment trap. Making interest-only payments can lead to much larger payments down the line when you need to start repaying principal and interest.
What can a personal line of credit be used for?
You have the freedom to choose how you use a personal line of credit. You could pay for home repairs, education expenses, unexpected bills or debt consolidation.
The benefit of a personal line of credit is that it can cover unpredictable costs. In comparison, a personal loan gives you a set amount of money with a set repayment period.
Who is a personal line of credit best for?
Personal lines of credit are generally for borrowers who have at least decent credit with some savings socked away.
A solid credit history and savings could qualify you for the best rates and avoid the need for you to put up collateral. But even if you’re opting for an unsecured credit line, a bank may ask to see additional verifiable assets.
Citibank extends its lowest interest rates to elite Citigold and Citi Priority customers or regular account holders with balances of over $200,000. To be a Citigold customer, you must maintain a balance of over $200,000 in eligible accounts. Citi Priority customers must maintain a balance of over $50,000 in checking, retirement and investment accounts at Citibank.
The products above are tailored to high-net-worth clients. Borrowers without six figures in the bank may still be able to qualify for a personal line of credit, but the rate and terms may be less competitive. Compare financial institutions to find which one benefits you the most.
Alternatives to a personal line of credit
Not sure if a personal line of credit is right for you? Consider these alternatives:
A personal loan is an installment loan. You can use the funds from a personal loan for a variety of reasons, from car repairs to medical procedures to weddings. Consolidating debt is a popular reason for taking out a personal loan.
These loans can offer a low fixed interest rate on a fixed term. If you’ve had trouble managing credit lines before, a personal loan gives you a set payment to keep up with until the debt is paid off.
Personal loan amounts can range from about $1,000 to $100,000.
How it works
You can apply for personal loans online through banks, credit unions and online lenders. Each will consider your credit, income and other variables to determine your eligibility for a loan. After you’ve been approved for a loan, the funds will be deposited into your bank account.
Who personal loans are best for
Personal loans are a product for almost anyone. There are personal loans available for people with stellar credit, as well as those who have less-than-perfect credit.
The best interest rates are usually given to borrowers with good to excellent credit scores — generally 640 and above. The good news is you can shop for personal loans to check rates without a hard inquiry for most lenders.
A home equity line of credit (HELOC) is secured by your home. HELOCs usually have a variable interest rate that can start out fairly low if there’s an introductory period. Be sure to ask about introductory rate expirations and rate caps to get a clear picture of costs.
How it works
HELOCs are offered through banks, credit unions and other lenders. You may be able to borrow up to 80 percent to 90 percent of your home equity value.
When you apply for a HELOC, your credit score, DTI ratio and the amount of equity you have in your home will be considered.
Some HELOC products allow for interest-only payments. That could be a perk if you need to settle other obligations. But it does come with the risk that you could be stuck in debt longer than you’d like.
Often, HELOCs have a draw period where you’re able to use the line of credit as needed. You may be able to renew the credit line after the draw period ends. If you don’t renew it, you’ll no longer be able to draw money and the repayment period will begin.
HELOCs may have closing costs, annual fees and prepayment penalties. Take care to read the interest rate and fee terms to avoid any surprises.
Who it’s best for
A HELOC is going to be best for borrowers who have sufficient equity in their home and decent credit. You may need a credit score of at least 620 to qualify. A score of 680 or above could make it easier to get approved.
Like a personal line of credit, a HELOC is a product for borrowers who have a history managing available credit responsibly. But a HELOC is secured by your home. If you fail to repay your debt, you could lose your house.
If you’re interested in shopping for a HELOC, you can compare products at the LendingTree marketplace. (Note: MagnifyMoney is owned by LendingTree.)
A credit card is a form of credit with which you’re probably pretty familiar. A credit card is a line of credit you can use on the fly. Some credit cards also offer rewards for transactions. You could, for instance, get cash back or earn miles toward free flights with a credit card.
Credit cards are offered by banks, credit unions and other financial institutions.
How it works
You can apply for credit cards online within a few minutes. Your financial information will be taken into account, including your credit history. If approved, the credit card issuer will provide you with a variable interest rate, spending limit, and any other fees associated with the card offer.
A minimum payment is due each month on your account. Over time, your rate can rise or fall. Depending on the card for which you apply, you may be responsible for paying an annual fee. Expect to pay fees for late payments and cash advances as well.
Who it’s best for
You can find credit cards for bad credit, but the best rewards programs and rates are reserved for those with excellent scores.
One major advantage to credit cards is sign-up promotions. Some cards offer a cash reward or bonus miles for signing up. You could even score an introductory 0% APR on purchases and balance transfers for periods of 15 to 20 months. Pay off your balance within that promotional period, and you essentially had a no-interest loan.
Credit cards are best for borrowers who are committed to using plastic and paying it off each month. That’s how you avoid interest charges. If you’ve had a problem with credit cards before, adding a new card to the mix may not be the best idea.
Making the right move for your finances
A personal line of credit has its merits. But you should weigh your options carefully. You may find a personal loan, HELOC or credit card is a better fit.
Ultimately, the right product for you will depend on your goals and financial situation. The best way to find the most competitive product for your needs is by shopping around and considering which products and features matter most to you.