When Laura Poole planned her wedding nine years ago, she found many vendors didn’t accept credit cards. Needing a little help to make her big day extra special, she took out a personal line of credit.
Personal lines of credit allow consumers like Poole to establish unsecured, ongoing borrowing relationships with financial institutions.
Thanks to her credit line, Poole could pay for the wedding she wanted. Over the years, she’s tapped into the line to pay off high-interest credit cards, cover unexpected car repairs and pay larger-than-expected tax bills.
“It just offers me a little extra flexibility,” says the life coach and freelance book editor from Durham, N.C. “It’s a great option if you have good credit.”
Advantages: personal line of credit
- Quick access to funds.
- Overdraft protection on some accounts.
- Competitive rates.
- Alternative to HELOC.
A personal line of credit can be a great resource when it’s used wisely, says Susan Tiffany, the Madison, Wis.-based director of personal finance information for adults with the Credit Union National Association.
“Think of it as tide-you-over money rather than flat-screen TV money,” says Tiffany, who recommends a personal line of credit as a “temporary, stopgap substitute for emergency funds.” However, personal lines of credit also have drawbacks. Interest rates tend to be higher compared with similar products, such as home equity lines of credit. As with other forms of credit, lenders are becoming more cautious about issuing new personal lines of credit.
In addition, because a personal line of credit is so easy to access, consumers must be “really disciplined” to avoid overborrowing, says Curtis Arnold, founder of CardRatings.com and author of two recent personal finance books.
“Convenience is a double-edged sword,” he says. “It can be too convenient.”
Boom to bust
During the housing boom, many people turned to HELOCs when they needed quick cash to pay for expected and unexpected expenses.
However, HELOCs can be tough to find today, especially in states such as Florida, California and Arizona, which have seen the bottom drop out of their housing markets.
“Standards are much tighter than they were a year ago” as banks try to weed out risky prospects, says Kenneth Alverson, managing director at the New York management consultancy Novantas.
Consumers shut out of the HELOC market might find a personal line of credit to be an attractive borrowing alternative.
Borrowers who use these products open a line of credit and tap into those funds as needs arise. As funds are repaid, the borrower can tap into the line of credit again and again without having to apply for new loans repeatedly.
Interest is charged only on the amount of money borrowed. Depending on the institution, consumers may be able to access the money through checks, Internet transfers, ATMs or a local bank branch.
Arnold says he’s “seen an uptick in the marketing of these products” in the past six to 12 months, with more offers landing in his home mailbox.
He says increased interest in personal lines of credit stems from “people turning away from credit cards and looking for other options.”
How to get one
Obtaining a personal line of credit typically requires a good credit score and solid credit history. However, as with HELOCs, lenders burned by the financial crisis are less willing to extend this type of credit than they were in the past.
So, it’s best to apply for a personal line of credit when your finances are healthy, Tiffany says, rather than waiting until you’re in dire straits and and possibly being a little less eligible.
“If you can qualify for a personal line of credit, you’re smart to take one out,” Tiffany says. “You should set it up when you’re in a position to be eligible for one.”
Alverson agrees that it’s best to apply sooner rather than later, since most forms of credit today “are being evaluated and managed more aggressively by banks to limit their exposure.”
“Get it before you need it,” he says.
Personal line of credit drawbacks
- Rates often higher than HELOC.
- Interest not tax-deductible.
- Hard to qualify with poor credit.
A quick survey of banks and credit unions finds that personal lines of credit are available in a variety of amounts and interest rates. San Francisco-based Wells Fargo offers personal lines of credit in amounts ranging from $5,000 to $100,000.
Underwriters are likely to approve borrowers with a strong credit history, a good relationship with the bank and verifiable earnings, says Brent Vallat, senior vice president and business manager for personal credit management at Wells Fargo.
Most requests are for amounts below $10,000. When someone wants to take out a line of $50,000 or more, “there’s a much more rigorous review of the client,” Vallat says. At that point, paperwork such as tax returns and documentation of personal assets is necessary for approval, he says.
Wells Fargo has surveyed its clients who have personal lines of credit and found that funds are typically used to consolidate debt, pay education or medical costs, or pay for used cars or home improvements. The money is usually repaid within 12 to 18 months, Vallat says.
At North Carolina State Employees Credit Union, based in Raleigh, N.C., about one-tenth of the credit union’s 1.5 million customers have personal lines of credit, although not all are actively used, says Bobby Gardner, senior vice president of lending.
He acknowledges that most customers “use them for things they probably should be budgeting for,” such as vehicle repairs, furniture, educational expenses and insurance costs.
They have remained popular over the years because “not all of our members are going to have a home,” so a HELOC is not always an option, Gardner says.
High rates, other drawbacks
While personal lines of credit may be the right choice for some, they also have drawbacks. For starters, personal lines of credit often have higher interest rates than HELOCs.
For example, customers who open a personal line of credit at the NCSECU pay double-digit interest rates for the privilege of borrowing.
The credit union does not used risk-based pricing when setting interest rates. Instead, customers pay 10.75 percent interest if they have their payment automatically deducted from their account or payroll check and 11.25 percent if they pay by another method, Gardner says.
At other institutions, such as Boeing Employees Credit Union in Seattle, pricing is risk-based, so the interest rate can run the gamut from 8.9 percent to 18 percent, says risk-model manager Will Gix.
The interest rates are slightly higher than those on BECU’s Visa credit card because the credit union has found that personal lines of credit carry a slightly higher risk of buyer default than the credit cards, Gix says.
By contrast, rates on HELOCs have hovered around 5.5 percent in recent months, according to Bankrate’s weekly survey of rates across the nation. To see the latest rates, click here.
In addition, interest payments on HELOCs generally are tax-deductible. That is not the case with personal lines of credit.
Convenience, other advantages
Still, personal lines of credit do have advantages. Many are tied to a checking account and also provide overdraft protection. People who are approved for a personal line of credit often can access the money within a day or two.
“A lot of people are starting to catch on to how easy and convenient they are to use,” says Clarissa Hack-Rodriguez, communications analyst with Security Service Federal Credit Union in San Antonio.
In addition, a person with a good credit history can get a personal line of credit with an interest rate of as little as 6 percent, she says.
“In times like this, they would be a useful option,” when money is tight and unexpected expenses can pop up, she says.
Other financial institutions offer secured personal lines of credit. Affinity Federal Credit Union in Basking Ridge, N.J., offers stock-secured lines of credit, through which the credit union takes custody of the stock certificate and lends up to 50 percent of its value, says Joan Grimes, assistant vice president of consumer loans.
“It’s always better with secured credit because the interest rate is more attractive,” she says.
And although personal lines of credit may have higher rates than HELOCs, the interest rates on personal lines of credit are usually much lower than a credit card cash advance or a payday loan.
Vallat believes personal lines of credit are a good option for many borrowers.
“It’s a really smart tool to have in your financial tool chest,” he says.