What is a personal line of credit and how does it work?

Money

When faced with unpredictable expenses or ongoing financial demands, people often find that standard borrowing products don’t quite fit their situation. A personal loan requires you to borrow a lump sum upfront, while credit cards can carry interest rates that make them expensive for larger expenses.

This gap in the lending market has led to the popularity of a financial tool that offers the best of both worlds — a personal line of credit (PLOC).

The basics of a personal line of credit

What Exactly Is a PLOC?

A PLOC functions much like having a credit card connected directly to your bank account, but with some distinct advantages. Think of it as a pre-approved pot of money that sits waiting for you to dip into whenever necessary. The financial institution evaluates your creditworthiness once during the application process and establishes a borrowing limit that remains available for your use.

Key Features That Set It Apart

Once approved, you can access funds from your line of credit through various methods such as online banking, ATM withdrawals, or writing cheques. The key feature that sets a personal line of credit apart is its revolving nature. When you repay the money you’ve borrowed, those funds become available to you again without requiring a new application or approval process.

Flexibility in Use and Payment

The flexibility extends to how you use the funds. Whether you need money for home renovations, educational expenses, debt consolidation, or emergencies, a PLOC adapts to your needs. You pay interest on the money you borrow from the day you withdraw it until you pay the balance back in full, which means unused credit doesn’t cost you anything. Unlike traditional loans, where you receive the entire amount upfront, you have complete control over how much you borrow and when.

How a personal line of credit works in practice

The Approval Process

The approval process for a PLOC involves a comprehensive review of your financial situation. Lenders will request personal information to confirm your identity and assess your creditworthiness. They’ll examine your credit score, verify your income through pay stubs or tax documents, and calculate your debt-to-income ratio to determine how much additional debt you can reasonably manage.

Determining Your Credit Limit

Credit limits vary significantly based on your financial profile. TD offers personal lines of credit with funds ranging from $5,000 to $50,000, though your specific limit depends on factors such as your income, existing debts, and borrowing history. Lenders want to ensure you can manage the additional credit responsibly without overextending yourself financially.

Many financial institutions, including trusted community-focused credit unions like Innovation CU, prioritize member relationships and often provide competitive rates alongside personalized service that helps members understand their borrowing options thoroughly. Credit unions typically offer the advantage of local decision-making and member-focused policies that can benefit borrowers seeking flexible borrowing solutions.

Interest Calculations and Rates

Interest charges work differently from traditional fixed loans. In Canada, most PLOCs have variable rates, often expressed as “prime + spread (increment %)”. The spread depends on things like your creditworthiness score, income, debt load, and whether you used collateral. The prime rate is tied to the Bank of Canada’s overnight/policy rate, and banks adjust their prime rates when policy changes. Currently, the prime rate is around 4.95%.

For example, if your PLOC has a rate of prime +2%, your interest rate would be about 6.95% per year. If you have a $10,000 credit limit but borrow only $2,000, you’d pay interest only on that $2,000 at ~6.95% until you repay it; the remaining $8,000 doesn’t accrue interest (though your agreement might include fees or minimum payments).

Repayment Structure

You’ll get a monthly statement showing the amount owing on your line of credit. You must make your minimum payment each month. Usually, your payment is equal to the monthly interest. However, you can pay more than the minimum at any time to reduce your balance and save on interest charges. Most lenders allow you to pay down your PLOC without penalty, giving you complete control over your repayment timeline.

Personal line of credit vs. Credit cards

What They Have in Common

Both personal lines of credit and credit cards fall under the category of revolving borrowing, meaning you can borrow, repay, and borrow again up to your approved limit. Both charge interest only on the funds you actually use, and both offer the convenience of accessing money when you need it without applying for a new loan each time.

The Key Differences

The most significant difference lies in interest rates. PLOCs typically offer lower interest rates compared to credit cards. The average unsecured personal line of credit rate was 9.4% while secured personal lines of credit averaged 5.65%, which generally compares favourably to card rates that often exceed 19% annually.

Access methods also differ between these products. Credit cards offer the convenience of point-of-sale purchases, online shopping, and widespread acceptance. PLOCs usually provide access through bank transfers, ATM withdrawals, or cheques, making them better suited for larger expenses rather than everyday purchases.

Personal line of credit vs. personal loan

Understanding Personal Loans

A personal loan provides you with a lump sum of money upfront, comes with a fixed repayment schedule, and typically offers either fixed or variable interest rates. Once you pay off a personal loan, the agreement ends, and you no longer have access to those funds.

How Lines of Credit Differ

A PLOC operates more like a financial safety net. You’re approved for a maximum borrowing limit, but you only take what you need when you need it. You pay interest only on the money you use, and as you pay down your balance, those funds become available again. The repayment structure is also more flexible, typically requiring only minimum monthly payments that cover the interest portion.

When to Use Each Option

The choice between these options often depends on your specific financial goals. Personal loans work best for defined, one-time expenses such as buying a car, funding a wedding, or consolidating existing debt into a single payment. The fixed payment schedule helps you budget predictably and ensures the debt is paid off within a specific timeframe.

PLOC suits situations with variable or ongoing costs. Home renovation projects exemplify this perfectly — you might need funds for materials, contractors, and unexpected issues that arise during construction, but the timing and amounts can be unpredictable. Similarly, if you’re managing irregular income or need access to emergency funds, the flexibility of a line of credit proves invaluable.

A PLOC can be a powerful financial tool

A PLOC serves as a financial bridge between the structured world of personal loans and the convenience of cards. It provides Canadians with a flexible borrowing option that charges interest only on funds actually used while maintaining access to approved limits for future needs.

The comparisons to other borrowing tools highlight its unique position in the lending landscape. Unlike personal loans that provide lump sums for specific purposes, PLOCs adapt to changing financial circumstances. Unlike cards with higher interest rates and spending temptations, they offer cost-effective access to larger amounts of funds.

A PLOC can be a powerful financial tool when used wisely, offering the flexibility to manage both planned expenses and unexpected financial challenges, but it requires disciplined financial management and may not suit every borrower.