While living debt-free is an excellent goal, borrowing money can also be a positive decision. Personal lines of credit and credit cards are among your options. They share a few key qualities, such as the ability to borrow a fixed amount of money on an as-needed basis, but are separate products with unique nuances.
Simply put, the main difference between personal lines of credit and credit cards is purpose. Personal lines of credit are ideal for large expenses, such as refinancing student loans or home upgrades to accommodate a growing family. Personal lines of credit can prevent excessive debt, while offering flexibility and security.
Conversely, credit cards are best for short-term financing. They’re great for covering expenses that are within your monthly budget.
Here’s what you need to know about personal lines of credit and how they compare to credit cards.
Personal line of credit
A personal line of credit is a specific sum that a lender allows you to borrow. The dollar amounts vary by lender — they can be as high as $50,000 or more, although many lines of credit are a lower sum. Because it’s a revolving line of credit, you can withdraw any amount up to the limit. Interest accrues only on the borrowed sum, not on the unused portion.
Depending on the lender, there may be restrictions for how you use personal lines of credit. For example, the money may not be spent on business and commercial expenses, or any illegal activities. Savvy reasons to use one for personal planned expenses include:
- Refinance your student loans
- Cover home expenses
- Finance or refinance a car
- Pay for medical or dental procedures
- Family planning, such as adoption or fertility treatments
- Private K-12 schools and education expenses
How to obtain and use a personal line of credit
When you apply for a personal line of credit, the lender will assess your credit history and financial capability. If the line is unsecured, eligibility depends on your capacity and creditworthiness. For a secured line of credit, you will offer collateral, such as real estate property or cash held in investment accounts; your capacity and creditworthiness will still factor into eligibility, but the requirements may be more flexible due to the collateral. An example of a secured line of credit is a home equity line of credit, also known as a HELOC. With a HELOC, you’re borrowing against the available equity from your home and the home is used as collateral for the line of credit.
Once you’re approved, the lender will offer you a line of credit that’s open for a specific period of time, called the draw period.
To access the funds, you may use special checks issued by the lender, a card that functions like a credit card or withdraw cash from a bank branch. A quick and convenient way is to use the lender’s online platform to shift funds from the line of credit into your checking or savings account.
Generally, after using the line, the lender will send you a statement with the minimum payment due, which is based on the amount you borrowed. When you make a principal payment, your account will be credited and you will have more access to the line of credit.
Any balance remaining after the draw period ends will be repaid during a repayment period, with a fixed payment term, in which you will make principal and interest payments.
Lengths of draw periods and terms of repayment may vary across lenders; for example, First Republic’s Personal Line of Credit consists of an initial two-year draw period, during which the borrower makes interest-only payments, followed by a repayment period, during which the borrower makes full principal and interest payments.
Interest and fees
Interest rates on personal lines of credit are usually variable, so they can fluctuate with the index (such as the prime lending rate) that they’re tied to. For this reason, you may want to find a lender that offers fixed rates on personal lines of credit. Because the rate remains constant, you won’t have to worry about rising interest rates impacting your amounts due.
For lenders who offer risk-based pricing, the interest rate you get primarily depends on your credit rating. If your credit scores are good to excellent, the rate will likely be lower.
Fees, too, can be associated with the line of credit, depending on the lender. They may include:
- An annual maintenance fee that ensures the line of credit is available during the draw period, which is charged on an annual basis or broken up into monthly increments.
- A late payment fee, if you are delinquent on payments.
- A transaction fee. Although not common, some banks charge a small fee each time you make a withdrawal.
When shopping around for a lender, don’t be afraid to ask about interest rates and fees as you evaluate your options. For example, First Republic’s Personal Line of Credit offers a fixed interest rate and does not have prepayment, origination or maintenance fees.
Generally, a bank will furnish the three major credit reporting bureaus with your account activity, and your credit scores will benefit when you keep the line of credit in good standing.
Payment history is the weightiest credit-scoring factor, so paying on time is important.
Like personal lines of credit, credit cards allow you to make charges up to a given credit limit. Initial credit card limits are often in the $5,000 to $10,000 range.
You can use a credit card to pay for any personal expenses, but they’re best for things that are within your budget. For example, you may want to charge groceries, clothes, gas and restaurant meals, then pay it all off at the end of the month.
Charging goods like pricey electronics and appliances can also be sensible. Credit cards offer valuable consumer protection, and if you pay off the debt within a few months, the interest costs may not be prohibitive. And if you have a rewards card, you can accumulate points, miles and cash with each purchase. Many also offer compelling perks, such as extra insurance and free checked bags at the airport.
How to obtain and use a credit card
You would apply for the account with a credit card issuer. Most accounts are unsecured, so qualification depends on your credit history. If you’re just starting out or are rebuilding damaged credit, you may consider pursuing a secured card, since you would put cash down as collateral that matches the credit limit.
Upon approval, you will have a credit card that comes with a fixed credit line. There is no draw period, so you can keep the account open for as long as you like. You may charge purchases in person, online or over the phone, and often can also withdraw cash at ATMs.
Minimum payments are based on your balance. If you repay the entire bill by the due date, no financing fees are applied to your debt. If you carry over a balance, interest will be added to the debt and your credit line will readjust with your payment.
Interest and fees
Interest rates on credit cards are usually variable. On top of that, each account may have several annual percentage rates (APRs), which is the interest rate — the nominal cost of borrowing the principal — plus any extra costs or fees that the lender may charge.
Pay close attention to the APR when evaluating your options; under the Federal Truth in Lending Act, all lenders must advertise the APR for consumer loans, so borrowers can make an informed “apples-to-apples” comparison between different products offered by different financial institutions.
Some credit cards may have a very low promotional rate for balance transfers and new accounts, but it may only last a fixed number of months. The regular purchase rate is the APR that’s attached to the things you buy. Many issuers charge higher APRs for cash advances. If you are delinquent on the account, the issuer may raise your rate to a much higher punitive APR.
Credit cards can also come with multiple fees, including:
- Late payment
- Balance transfer
- Cash advance
- Foreign transaction
In general, credit card interest rates and fees are higher than those on personal lines of credit, so it’s especially important to keep debt low, if not at zero. For expenses that you do want to finance with a credit card, create a swift and steady payoff plan.
Credit cards appear on your credit reports, and your account activity affects your credit scores. As long as you send all your payments on time and maintain a low balance relative to your credit limit, your credit scores will benefit.
The bottom line
Not all debt is bad; more than ever, it’s wise to plan and ensure that you have access to money for when the time is right.
Credit cards and personal lines of credit are often compared to each other, but it’s crucial to learn the difference between the two types of products, so you can make the right borrowing choice for your financial situation and your goals. With credit cards, you can pay for a range of affordable short-term expenses, and come out ahead with their consumer protection and rewards programs. To finance expensive planned purchases and reduce the cost of existing debt without hurting your bottom line, a personal line of credit can be a powerful addition to your credit portfolio.
Now that you know the difference, evaluate your options and consider whether First Republic’s Personal Line of Credit might be a fit for you.