What is a personal line of credit? Pros and cons explained

If you want to pay for renovations on your home, have access to cash for investments, or even just be able to access funds in the case of an emergency, a personal line of credit may be an option. So what are they exactly, and how do they work?

What is a personal line of credit?

A line of credit is an open-ended loan that lets you withdraw funds flexibly for a period of time, up to a set credit limit. You only pay interest on funds you have withdrawn.

A personal line of credit loan is similar to a credit card, in that it can be used to draw funds out, and then repay them, when and as needed. Line of credit personal loans typically have higher interest rates than other types of personal loans.

There are also lines of credit available for home loans where you use your property as security against the loan.

How is a line of credit different from a standard personal loan?

A key difference between a line of credit personal loan and a standard personal loan is that a line of credit is more flexible. A standard personal loan will have a fixed term, over which the loan principal and any interest charges are to be repaid. A line of credit is different, in that the borrower will have access to funds up to a set limit, and can draw on them and repay them at their own discretion, often with a flexible repayment schedule.

What can a personal line of credit be used for?

A line of credit can be used for any purpose. Some people might use one to pay for renovations on a home, while others might use the funds to pay for living expenses such as medical bills or a car.

Some might even use a line of credit to pay for a major expense such as a wedding or holiday. But before taking on debt for a purpose such as this, it is worth considering whether you are making a wise decision for your financial future by doing so, as there will be interest charges and potentially fees to budget for.

What credit score do you need for a line of credit?

There is generally no strict credit score requirement to be approved for a line of credit personal loan, although typically, the higher your credit score, the more favourably lenders will consider your application. Your credit report shows details of your credit history, from regular repayments through to loans and bankruptcies.

If your credit score is not as high as you would like it to be, there are ways that could help improve it. A higher credit score can potentially mean a lender might charge you less interest, or give you access to a larger amount of credit on a line of credit loan.

How hard is it to get approved for a line of credit?

The lending criteria for a line of credit will generally be the same as applying for any other personal loan. You will need to supply your lender with:

• proof of your identity;
• proof of a regular income (in the form of PAYG payslips);
• proof of savings (in the form of bank statements), and;
• a list of your assets and liabilities.

A lender will consider these factors, as well as your credit score, when deciding if and how much to approve you for.

What is the easiest line of credit to get?

Your chances of approval may also depend on whether the line of credit you are seeking is secured or unsecured. Secured lines of credit may generally be easier to get than unsecured lines of credit, as lenders may consider an unsecured line of credit to be riskier.

Secured line of credit

A secured line of credit means that an asset you own will need to be used as collateral for the loan, such as a house or a car. These types of loans typically have lower interest rates than unsecured loans; however, the lender will have the right to sell the asset in order to recoup the balance of the loan if you fall behind on your payments.

Unsecured line of credit

Unsecured lines of credit do not require an asset to be used as security, which means lenders typically consider them riskier. You may require a high credit score to take out an unsecured line of credit. Keep in mind that the interest rate attached may also be higher, and the credit limit lower.

What are the pros of a personal line of credit?

There can be convenient aspects to a line of credit, including ease of access to funds, the flexibility of repayments and the possibility of a financial safety net:

Only one application required

When you take out a personal line of credit, you will be able to keep drawing funds up to your approved limit, as well as make repayments, whenever it’s convenient. This means you will not need to apply for a new loan each time you need to borrow money; rather, you will have one loan that will allow you to draw and repay as required. You may still be charged a monthly fee, even if you have not drawn on your line of credit.

You’re only charged interest on what you use

While the interest rates on lines of credit are typically higher than other types of personal loans, you will only be charged interest on the amount that you have actually drawn. Given the flexibility of lines of credit loans, it can be difficult to predict the exact amount of interest you will be charged.

A financial safety net

If you feel you are able to manage your money without being tempted to overspend on purchases that you don’t really need, then a line of credit could be a useful financial safety net, providing access to funds if you need them in an emergency. It could be worth considering seeking out a lender that will not charge you a monthly maintenance fee when your line of credit is unused.

What are the cons of a personal line of credit?

There are a number of possible downsides to a line of credit, including the potential for high fees and charges and strict penalty clauses, as well as the temptation to overspend:

Higher fees and charges

The flexibility of a line of credit comes at a cost. Typically, there will be higher interest rates attached to a line of credit than there will be for a standard loan. Plus, a line of credit will typically have monthly fees – some lenders may charge monthly fees regardless of whether or not the line of credit is used, while some may only charge a monthly ‘maintenance’ fee if it is not used.

Penalties

Lines of credit come with flexible repayment terms, but you may like to read the terms and conditions carefully to better understand exactly how much you will need to repay and the terms and conditions of the loan. Failure to abide by the loan terms could see you incurring penalties from your lender, and this could cost you significantly more than you planned for.

Temptation to spend

If you wish to take out a line of credit personal loan, it may be worth first considering how well you manage money. The ease of access to funds, coupled with the flexibility of repayments, could lead to a temptation to overspend. If you do not manage your money carefully, you could find yourself in quite a lot of debt.

If you are considering taking out a loan but are unsure if a line of credit is appropriate for your needs and situation, you can compare personal loans to find a loan product with terms and features that may suit you. You may also like to consider seeking independent financial advice to support your personal decision making.

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