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A personal line of credit is a versatile tool some people use to meet their financial needs, but it isn’t the best option for every financial situation. A personal line of credit offers flexibility when you’re not sure exactly how much money you need to borrow, but that flexibility can come at a cost.
When Does It Make Sense to Get a Personal Line of Credit?
Home improvement projects: Home improvement projects often increase the value of your home, but the total cost of the project can vary wildly from the initial estimate. You should have a good idea of how much you plan spend to make sure costs don’t get out of control, but you won’t know if you need access to contingency funds until after the project gets started.
A personal line of credit gives you the flexibility to access the cash, if needed, but it doesn’t require you to borrow if your home improvements go according to plan. Additionally, you normally don’t need all of the cash for a home improvement project upfront. By taking out cash from a personal line of credit as you need it, you’ll only pay interest on the amount you’ve borrowed at any given point.
In the best-case scenario, once the home improvement project is completed, an appraisal may show an increased home value. With an increased home value, you may be able to take out a lower-interest home equity loan to pay off the personal line of credit you used during the home improvement project. But remember to factor in the closing costs needed to get a home equity loan when contemplating this route.
When cash flow is tight: Money doesn’t always come in when you need it. If you have a large influx of cash coming at a definite future date, a personal line of credit could tide you over until the cash arrives. For instance, say you’ve closed on a new home but you’re still waiting for your former home’s sale to be completed. It may be difficult to make two mortgage payments, so as long as the closing date is set and the buyer of your old home can’t back out of the contract, a personal line of credit can give you some financial flexibility until you get the proceeds from the sale of your old home.
However, you don’t want to take out a personal line of credit if you’re unsure of the future influx of cash. For example, if your old home is under contract, but the potential buyer still has to do a home inspection or has access to other clauses that could let them back out of the contract, relying on the money from the sale of the home to pay off a personal line of credit is risky.
When It Doesn’t Make Sense to Get a Personal Line of Credit
Purchasing luxury items: Using a personal line of credit to purchase luxury items, such as motorcycles or personal watercraft, usually isn’t a good idea. Instead, wait until you can pay cash for these items, or get a secured loan that offers a lower interest rate.
Weddings: Even though the total cost of a wedding may be unknown, using a personal line of credit to pay for a wedding isn’t the best idea. If you can’t pay cash for a wedding, either wait until you can, or reduce the cost of your wedding. Incurring a large amount of debt for a one-day event could put unnecessary stress on your future marriage and your finances, too.
Vacations: A personal line of credit is not the way to pay for a vacation you can’t afford to pay cash for. In fact, debt shouldn’t be used to pay for vacations in general. While it’s easy to argue you may not know the total cost of a vacation before you leave, researching your destination should give you a good enough idea of how much you need to save before you leave on vacation.
When your budget doesn’t balance: While a personal line of credit can help solve a short-term cash flow issue when you know additional cash is on its way, you should never use a personal line of credit to help you balance a budget that consistently results from spending more than you earn. Instead, work to cut expenses or earn more income to cover the budget shortfall. A personal line of credit will only make the situation worse.
Alternatives to a Personal Line of Credit
If you can’t get a personal line of credit, or you realize that a personal line of credit isn’t the best way to borrow the money you need, here are a few other options that might work better for your situation.
Personal loan: If you have a set amount you know you need to borrow, rather than an unknown range, you may be better off using a personal loan to borrow the money you need. Personal loans usually allow you to borrow at a fixed interest rate over a term that usually ranges from one to seven years.
Promotional rate credit card: If you know you’ll be paying off the amount you borrow in a short period, a credit card that offers a 0% APR promotional interest rate on purchases may work out better than a personal line of credit. The promotional period usually lasts from a few months to as long as 18 months. Regular interest rates usually apply after the promotional period expires, so be sure to pay off the amount you borrow before the introductory period ends.
Home equity line of credit: If you have access to home equity, a home equity line of credit (HELOC) may be a better option than a personal line of credit. Because a home equity line of credit is secured by your home, meaning the lender could foreclose on your home if you defaulted on your loan, you can usually obtain a lower interest rate on a HELOC than you’d get with a personal line of credit. However, the higher costs involved with setting up a HELOC may make a personal line of credit a better option if you’re only borrowing a small amount or over a short period.
Home equity loan: Similar to a home equity line of credit, home equity loans can offer lower interest rates due to the secured nature of the loan. Home equity loans may work better for you when you have a set amount you need to borrow. Unlike HELOCs, home equity loans normally offer fixed interest rates, which can be helpful if interest rates are rising.