Is a Personal Line of Credit a Good Idea?

Personal lines of credit are typically used as a means to pay off high-interest credit cards, pay for unexpected expenses and for everyday purchases. Some banks offer personal lines of credit to their customers. Opening a line of credit can lead to financial stability or a mountain of debt, depending on how the credit is used.

Definition

Many people confuse personal lines of credit with personal loans. A personal line of credit is a line of credit extended to someone by a bank. Personal lines of credit differ from loans in that loans essentially give someone money that the borrower immediately begins to pay back, with interest. A personal line of credit gives the person access to funds, but the person can tap into the line of credit whenever he wishes. A personal line of credit also differs from home equity loans and home equity lines of credit, because a personal line of credit is unsecured; your house is not tied to the line of credit.

Financial Responsibility

Since a personal line of credit is similar to a credit card, you'll need to repay whatever credit you use at the specified interest rate. Failure to repay what you borrow will lead to a poor credit score and the inability to open another personal line of credit down the road. People who have difficulty with spending money should consider if they have the discipline to open a personal line of credit. Curtis Arnold writing for Bankrate.com advises that since the credit is available at any time, a person with poor financial discipline can go on a buying spree without the ability to pay the borrowed amount back. According to Lendingtree.com, 35 percent of your credit score is based on your payment history, so failure to repay the borrowed amount could lead to a plunge in your credit score.

Consolidation

If someone has several high-interest credit cards and wants to pay off debt, opening a personal line of credit is a good idea. Personal lines of credit tend to come with lower interest rates than credit cards. The person could tap into the line of credit and eventually pay off the high-interest credit cards while paying a lower interest rate towards the personal line of credit. While a home equity loan or line of credit often comes with lower interest that can be deducted from taxes, the upside of a personal line of credit is that you don't risk your home if you can't pay back the amount you borrow.

Emergency Funds

A personal line of credit can serve as a person's emergency funds if that person either doesn't have an emergency fund or the fund runs out. An emergency might be sudden unemployment or a major illness. Some people use credit cards as an emergency fund, but the high interest rate often leads to a buildup of debt. According to indexcreditcards.com, the average credit card interest rate is 16.87 percent as of January 15, 2011. Interest rates for personal lines of credit tend to vary from bank to bank and are based on the "Wall Street Journal" Prime Rate. For example, a bank may assign you a base rate of 9 percent interest plus the "Wall Street Journal" Prime Rate, so, while rates will vary, they will be considerably less than credit card interest.

Cash

Personal lines of credit are often linked to a person's checking account, which allows for the withdrawal of cash. Unlike a credit card, there is no extra fee to withdraw the credit as cash. Some people are wary of using credit cards, due to fraud and sometimes hidden fees. A personal line of credit serves as an alternative tool for people who wish to have access to credit but use it like cash.