When you have an unexpected expense you don’t have the cash for, or when you’re behind on your bills, you may think the best solution is your credit card.
However, opening a credit card can be a hassle, and it isn’t the only (or necessarily the best) way to get access to money when you need it the most. Getting a personal line of credit can be a smart option.
When it comes to choosing the best personal line of credit, it pays to understand what it is, how they’re different from personal loans, and the importance of comparing rates.
Here’s an in-depth look at how personal lines of credit work and how you can find the best one.
What is a line of credit for and how does it work?
A personal line of credit is similar to an unsecured credit card. You don’t have to provide collateral to take one out, such as an auto loan or a home equity loan.
With a personal line of credit, a lender will pre-approve you to borrow up to a maximum amount. You can take out as much money as you need—up to your line of credit maximum—at any given time. You generally get access to funds by writing a check, electronic transfer, or sometimes with your ATM card.
Once you take money out, repayment starts right away, and you’re only charged interest on the amount you took out. Lenders typically set a minimum payment amount, and interest rates are variable, meaning it can go up or down depending on the prime rate.
You may also need to pay an annual fee for an account, and you’ll need to pay this fee whether or not you borrow any money.
What is the interest rate on a personal line of credit?
Interest rates for personal lines of credit vary dramatically by type, lender, and credit score. Some lenders offer rates as low as 7% APR while others can charge as much as 450% APR. Banks and credit unions tend to have lower rates but more stringent eligibility requirements. However, nonbank lenders, such as Upstart, have some of the best rates and terms in the sector.
In general, rates tend to be lower than what you could get with a credit card. However, rates will go into the three figures for subprime borrowers. Your rates will vary depending on your score, the amount you borrow, and the lending laws in your state.
Of course, it doesn’t matter how low your rates are if you can’t afford the payments. So, make sure you only borrow as much as you can afford to repay.
If you can’t pay back your loan on time, you may have to pay penalties and risk damaging your credit score. Before taking out any loan, play around with a line of credit calculator to see what your monthly payments could be.
What is the difference between a personal loan and a line of credit?
As mentioned before, a personal line of credit lets you borrow as much you need up to a maximum amount. Since it’s a variable interest rate, your payment will vary as well. Read this for an in-depth analysis of the pros and cons of a personal line of credit.
A personal loan is different in that you get a lump sum up front with a fixed interest rate. That means you know exactly how much you’re paying each month. People who take out personal loans tend to use them to consolidate high-interest debt, such as ones for credit cards.
Personal loans are best for those who have a set amount they want to borrow. Whereas a line of credit is best for those who want to have money available in case of emergencies or for overdraft protection.
Neal Frankle, a CFP, warns that some places aren’t looking out for your best interest. “Some payday loans and other types of money advances are what I consider loan sharks,” he says. “They charge astronomical rates, and it can be very difficult to escape that debt purgatory once you start doing business with such people.”
Here is a list of the benefits and the drawbacks to consider.
- You only need to borrow the money you need.
- Only pay interest on the money you actually borrow.
- Flexible repayment options.
- Constant access to funds.
- Typically you qualify for lower average APR than credit cards.
- Unsecured credit lines risk no collateral.
- Option to provide collateral for lower interest rates (secured loan).
- Fewer restrictions on loan purpose.
- Ideal for long-term projects with open-ended costs.
- Good for temporary cash shortfalls.
- No withdrawal limits (up to credit limit).
- You can’t deduct the interest as an expense.
- The variable rate on the line of credit may increase.
- Some lenders charge annual/monthly maintenance fees.
- Fixed rate loans tend to have lower rates.
- Not a great option for debt consolidation.
- Fees/APRs vary widely by lender.
- Some lenders require you to have a checking account with them.
- You need good credit (although some lenders do cater to poor credit customers).
- Not a great option for long-term cash shortfalls.
- Some consumers may be tempted to overspend.
- A high credit usage could hurt your credit score.
How can I qualify for a line of credit?
Qualifying for a line of credit typically means you need a great credit score. Many lenders are more willing to offer you one and at a lower rate if you do.
Before applying, check your credit score and credit report to see what you may be able to qualify for. Many places offer free credit monitoring tools, so take advantage of those services.
You can get a free credit report from the three major credit reporting bureaus each year by going to AnnualCreditReport.com. Once you get your reports, look over them with a fine tooth comb to see if there are any discrepancies or errors. If so, then it’s a good idea to fix them before applying for a loan.
Once you know what your credit score is, then you can confidently shop around. It also doesn’t hurt to call your local credit union to see what they may be able to offer, as these places tend to have lower rates.
If your credit score is less than stellar, don’t worry. You may be still able to get a personal line of credit with a favorable rate with lenders like Elastic, Mobiloans, and CashNetUSA.
For example, some banks are more willing to work with existing customers, especially those who have been loyal or have large deposits in their accounts.
Banks like Wells Fargo and Chase may be able to give you rate discounts or even waive annual fees, depending on the type of customer you are.
How to find the best personal line of credit for you
Getting the best personal line of credit for your needs will mean looking at the best rates and the maximum you plan on taking out. You’ll also want to think about the reasons why you want to borrow money.
If you intend on using the money for your property, like making repairs, it may be better to get a home equity line of credit (HELOC). HELOCs work much like a personal loan, except you’re putting your home up for collateral. HELOCs may have a lower rate, so it’s worth shopping around to see what you qualify for.
Otherwise, if you can qualify for a decent rate, a personal line of credit could be a good choice. To find the best fit for you, review and compare personal lines of credit side-by-side today.