Credit is a useful tool you can use to control your financial future. This is especially true when it comes to large, unexpected or emergency expenses that pop up. Having the ability to make a purchase with a credit card and work to pay it off later can ease a lot of tension and help you cover hefty expenses. But could a personal line of credit be a better route?
Part of using credit wisely is learning which types work best for you. In this article, we’ll introduce you to two types of revolving credit: personal lines of credit and credit cards.
Each of these options can provide you with the opportunity to better navigate your finances, but knowing which one is the best to use in your individual situation might end up saving you money and reducing your financial burdens.
What Is a Personal Line of Credit?
A personal line of credit operates under the same concept as a credit card, with slight differences. It’s a type of revolving credit that allows you to borrow a set amount, which is typically based on your income.
The majority of personal lines of credit are unsecured, meaning there’s no collateral at risk if you default on payments. However, you can obtain a secured personal line of credit at some institutions if you put down a deposit. This deposit will be used to pay your balance due if you default on payments, but it can also help you achieve a lower interest rate. Personal loans secured by a deposit are typically used as a method for building credit.
A home equity line of credit is similar to a secured personal line of credit in that your house acts as the collateral in the loan. If you default on payments, your house could be foreclosed on to make up the difference. Instead of borrowing credit, however, you’ll be borrowing against the equity already within your home.
How Does a Personal Line of Credit Work?
As with any other credit transaction, personal lines of credit are reported to the three major credit bureaus. You will have to provide details about your financial standings in order to qualify for a personal line of credit. Typically, this comes in the form of demonstrating your income, in addition to other requirements.
Some banking institutions may require you to have a checking account established with them before offering you a personal line of credit. This is critical for using your personal line of credit, since the money can be transferred to a linked checking account.
Personal lines of credit contain what’s called a “draw period.” During this predetermined amount of time you can use your available credit as you please, as long as you don’t go over the limit. However, once the draw period reaches its end, you may be required to either pay your remaining balance in full or pay it off by a certain date after that.
For example, you may obtain a personal line of credit in order to buy supplies for your business. Even if you use the entire balance, say $10,000, you aren’t required to pay more than the minimum monthly payment. This allows you to have products to sell as well as the time to produce a profit before having to pay the credit back.
After obtaining a personal line of credit, you’ll either use special checks to move money into your checking account, or a payment card similar to a debit card to access your line of credit. The interest rate for a personal line of credit usually fluctuates with the market conditions, such as the prime rate. You may also have to pay a fee each time you use your personal line of credit.
What Is a Credit Card?
A credit card is a type of unsecured revolving credit that includes a credit limit. This limit is determined by your financial situation, which requires a hard credit check. There are credit cards for practically all types of credit scores, from poor all the way up to excellent.
You can charge as much as you’d like to a credit card, as long as you don’t exceed your credit limit. You can even ask for increases on most credit cards, which are often granted when you make your payments on time and your credit improves.
Many credit cards offer rewards in the form of cash back or travel rewards. You may also receive a bonus for signing up for a new account, either as rewards or as an interest-free, introductory financing period. Also, a credit card can offer cardholder benefits such as purchase protection or travel insurance.
How Does a Credit Card Work?
Your personal bank or other financial institutions may offer their own credit cards, but you don’t have to belong to a particular bank or lender in order to qualify for a credit card. After you’ve been approved, the lender will likely set a credit limit.
When you make a purchase with a credit card, it constitutes a loan. At the end of each billing cycle you’ll receive a statement. You can usually avoid interest charges by paying your statement balance in full, or choose to pay a lesser amount and incur interest charges. If you don’t make a payment by the statement due date, you will likely also incur a late payment fee. Interest charges and fees are added to the account balance, and interest will accrue on this new total.
Personal Lines of Credit Vs Credit Cards Compared
Now that you know a bit more about both credit cards and personal lines of credit, let’s take a closer look at how they compare.
Similarities
Both personal lines of credit and credit cards are types of revolving credit. This means you can borrow up to a certain amount as much as you’d like as long as you pay the balance back down in order to make room for future purchases.
Both personal lines of credit and credit cards also report your balance and payment history to the three major consumer credit bureaus.
Differences
Here’s a quick summary of the main differences between personal lines of credit and credit cards.
| Features | Personal Line of Credit | Credit Card |
|---|---|---|
| Interest rate | Ranges from 8.25% to 17.74% | Ranges from 8.99% to 29.99% |
| Borrowing limit | $100,000 | $500,000, but most often it’s under $10,000 |
| Rewards | None | Many cards offer cash back or travel rewards |
| Fees | Annual fee ($25 to $50), late payment fees, fees for drawing on account | Annual fees, balance transfer fees, late payment fees, overdraft fees |
| Application process | Can be lengthy | Very simple |
| Grace period | No | Yes |
| Other benefits | Good for emergency and/or unexpected expenses | Many cards offer travel insurance, purchase protection, and other benefits. |
Pros and Cons of Personal Lines of Credit
There are times when a personal line of credit can make life much simpler. However, you may have to accept certain tradeoffs.
| Pros | Cons |
|---|---|
| Lower fees for a cash advance | Potential fees for usage |
| High borrowing limits | Pre-set credit lifespan |
| Low interest rates | No spending rewards or perks |
| Funds can be used at your discretion | No interest-free grace period |
| You only pay interest on what you borrow | Annual fee |
Pros and Cons of Credit Cards
Credit cards are a powerful financial tool you can use to wisely manipulate your money. Knowing the terms of the game, however, is just as important as learning how to be responsible with credit cards.
| Pros | Cons |
|---|---|
| Many cards offer rewards for spending | Some cards have annual fees |
| Can be used for retail purchases | High interest rates |
| One for practically every credit score | Hefty fees for cash advances |
| Useful tool in establishing and/or rebuilding credit | Balance transfer fees |
Alternatives to Revolving Credit
Besides personal lines of credit and credit cards, there are a few other types of financial products you can use.
Personal Loans
It may be easy to get personal loans vs. lines of credit confused, but it’s crucial to know the difference. For example, a personal line of credit is a potential amount that can be borrowed. Personal loans, however, are a lump sum of money that you receive shortly after your approval. This is what personal installment loans are.
Obtaining either a secured or unsecured personal loan requires a credit check. The potential amount you may be able to borrow ranges from $1,000 all the way up to $40,000 or more. And while some personal loans are taken out for a specific purpose, such as a home renovation, a personal line of credit can often be used for any reason.
For example, you may want to go with a personal loan instead of a line of credit if you need to make home renovations. This is especially true if you’re looking at redoing your kitchen. Appliance loans can come with hefty fees and interest rates, but a personal loan isn’t subject to the same restrictions.
A personal loan rate calculator can be used to see what terms you may be able to expect. While these calculators may not give you the exact terms you’ll receive if you do obtain a personal loan, they can be a great starting place.
Auto Loan
Many people don’t have thousands of dollars sitting around to help pay towards a new car, so they use auto loans. An auto loan is a personal loan that’s secured by the title of the vehicle. If the borrower fails to pay the loan, the vehicle can be repossessed. And the name of the lender typically appears on the title of the car, so the loan must be paid off before the car can be sold.
Mortgage
A home mortgage, or home loan is a loan that’s secured by a real estate property. Because of the inherent value of real estate, a home mortgage can often have a lower interest rate than other types of secured loans. Most home mortgages are installment loans that have a fixed repayment period, such as 30 years or 15 years.
A home equity loan or a home equity line of credit is a second mortgage taken out against the existing equity in a property. Because of their low interest rates these are sometimes used instead of unsecured personal loans.
Student Loans
If you’re considering taking out a loan to help pay for college, there are other options besides a personal line of credit, which some lenders may not allow for college expenses. In fact, many institutions offer student loan terms that set you up for success when it comes time to pay back those loans. For instance, you may not need to start paying those loans off until you’ve graduated.
Federal student aid can help pay for college-related costs as well. The Free Application for Federal Student Aid (FAFSA®) is one determiner of how much and what type of federal student aid students and parents might qualify for. Some individual colleges also use the FAFSA in determining eligibility for their own financial aid programs. (Before considering private student loan options, all federal student loan options should be exhausted.)
The Takeaway
Personal lines of credit are similar to credit cards in that they both are generally unsecured loans issued based on your personal creditworthiness. By understanding how a credit card differs from a personal line of credit, you can choose the loan that best fits your needs.
Check out what your individual interest rate could be without affecting your credit score.* Those emergency funds you need could be only a personal loan application away. It only takes one minute to see what our rates are for a SoFi Personal Loan.
FAQ
Here’s a list of the most common questions associated with personal lines of credit and credit cards.
Is a personal line of credit the same as a credit card?
Personal lines of credit and credit cards are not the same. A credit card is a form of payment accepted by merchants while also being a revolving loan. A personal line of credit is a revolving loan, and the funds are typically transferred to the borrower’s personal bank account before they are used for purchases. Credit cards can also have numerous features and benefits not offered by a personal line of credit.
Are there additional risks to lines of credit vs credit cards?
Both personal lines of credit and credit cards require you to pay back what you owe, whether it’s on a monthly basis or at the end of the draw period, in the case of a line of credit. Making late payments or missing payments can negatively affect your credit score.
Do personal lines of credit affect your credit score?
Yes, personal lines of credit, just like credit cards, are subject to reporting to the major credit bureaus. If you make late payments or miss payments, your credit score can be negatively affected. However, personal lines of credit can also be used to improve your credit score if you make your payments on time and use your credit responsibly.
*Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
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