A line of credit is flexible, easy to use, and accessible. As an alternative to personal loans and credit cards, a line of credit from your financial institution can mean lower costs, too.
Learning more about lines of credit can make your decision about whether to apply for one a little easier.
Let's take a closer look at lines of credit for individuals and how they work. We'll review secured and unsecured lines of credit, how these offerings are structured, their unique benefits, and much more.
What Is a Secured Line of Credit?
A secured line of credit is a type of loan that’s backed by collateral—an asset like your home, vehicle, or even mortgages—which the lender can seize if you fail to meet your repayment obligations. This arrangement reduces the lender’s risk, making it easier to qualify for a loan, even if you have a less-than-perfect credit score.
Secured lines of credit often have lower interest rates than unsecured options, offering you more manageable repayment terms. They’re commonly used for home improvements, education, or unexpected expenses. Providing collateral can improve your approval chances and give you access to higher credit limits.
Pros of a Secured Line of Credit
A secured line of credit has multiple advantages. Since collateral acts as a guarantee that your loan will be paid back, a secured line of credit comes with lower interest rates than an unsecured line of credit. This option also means higher borrowing limits.
The extra layer of security offered by collateral makes lenders more comfortable extending credit limits. Collateral also increases the odds of approval for individuals with lower credit scores, as lenders can secure their loan with an asset equal to the loan's value.
Cons of a Secured Line of Credit
Despite the benefits of a secured line of credit, this borrowing option has some downsides. First, if you fail to repay the loan according to the preset conditions, the lender has the legal right to seize the collateral to offset the loss.
Another shortcoming of a secured line of credit (LOC) is the potential for a longer application process. Securing the loan with collateral means the asset may need to be assessed to ensure its value, which takes time. However, the better rate and repayment terms you receive with a secured LOC may well be worth any additional waiting time.
An Example of a Secured Line of Credit
A common version of a secured line of credit is the home equity line of credit, where you receive funds against the equity in your home. For example, if your home is worth $400,000 and you have a mortgage balance of $200,000, your equity would be $200,000. A lender might offer a home equity line of credit with a credit limit of up to 80% of your equity, which in this example would be $160,000.
What Is an Unsecured Line of Credit?
An unsecured line of credit doesn’t require collateral. The lender offers you a loan based mainly on your credit history and cash flows. With no borrower assets available for recovery in case of non-payment, the lender assumes a greater risk when granting an unsecured line of credit.
As expected, this type of loan is more challenging to acquire. An unsecured line of credit also has higher interest rates to compensate for the increased risk the lender takes on. Without collateral for assurance, the lenders are likely to negotiate stricter repayment conditions as well.
Pros of an Unsecured Line of Credit
The primary perk of an unsecured line of credit is straightforward: you don’t risk losing assets. If you default on your payments, there is no collateral to be seized. Still, adhering to the lender’s terms should be a priority to avoid dealing with debt collectors and keep a good credit score. Your responsible repayment approach can even help you build creditworthiness for future loans.
The second benefit to an unsecured line of credit is the reduced time it takes to apply. With no need to establish collateral ownership or appraise the value of your assets, an unsecured line of credit can be arranged quickly.
Cons of an Unsecured Line of Credit
An unsecured line of credit poses more risk for lenders, so they set lower borrowing limits. With no collateral to back their loan, lenders can charge you higher interest rates to balance the increased risk of default as well. An unsecured line of credit can also be more difficult to obtain if you have a low credit score since a strong credit history is essential to qualify without collateral.
Being riskier for lenders, unsecured loans often have stricter terms and payment schedules. Plus, these lines of credit have a greater impact on your credit score. If you make timely payments, they can boost your credit rating. However, if you fall behind, the missed payments will undermine your creditworthiness.
Secured Line of Credit vs. Unsecured Line of Credit
Criterion for Comparison | Secured Line of Credit | Unsecured Line of Credit |
Collateral Requirement | Backed by collateral | No collateral |
Interest Rates | Lower interest rates compared to an unsecured line of credit | Higher interest rates compared to a secured line of credit |
Borrowing Limit | Higher credit limit | Lower credit limit |
Difficulty of Approval | Easier to approve provided the borrower has a valuable asset to serve as collateral | Harder to approve for individuals with lower credit scores |
Risk to Borrower | The borrower risks losing the asset in the event of default | Defaulting payments lead to lawsuits and considerable damage to credit score |
Personal vs. Business Line of Credit: Key Differences
A business line of credit and a personal line of credit are very similar. They have the same basic structure and purpose—to provide access to money, up to a preset limit, when you need it.
The differences between these types of revolving credit come in the application process and how they're used. Lenders will focus on a company's creditworthiness when deciding about a business line of credit. For a personal line of credit, lenders review your personal finances and related factors: your income, credit history, and current debt.
Business lines of credit are intended for business purchases and expenses. On a practical level, they're similar to business credit cards. It's simply not a good idea to use either type of credit for personal purchases. Mixing personal and business finances can lead to complications with taxes and other issues.
Are There Any Downsides to Unsecured Lines of Credit?
Unsecured lines of credit offer a borrowing option that doesn’t require collateral, making them attractive to many individuals. However, this flexibility comes with potential risks and challenges that borrowers need to understand. While they provide quick access to funds and eliminate the worry of losing assets, they can still create financial strain if not managed carefully.
So, what are the downsides?
An unsecured line of credit is typically not the best option for borrowing substantial amounts due to its higher risk for lenders, which often results in elevated interest rates. Additionally, unsecured lines usually have lower credit limits, making them less suitable for covering significant expenses.
In contrast, secured credit offers higher limits and lower interest rates and is generally easier to qualify for.
Having easy access to credit can be a valuable financial tool when managed responsibly. To make the most of it, it's essential to have a clear plan for regular monthly payments, ensuring your budget stays on track and supports your financial goals.
This proactive approach helps you enjoy the benefits of credit while maintaining financial stability.
An Example of an Unsecured Line of Credit
Suppose a borrower with good credit is approved for a $10,000 credit limit to use for unexpected expenses, like medical bills or home repairs. No collateral is required, and interest accrues only on the borrowed amount. While convenient and flexible, unsecured lines typically come with higher interest rates, and timely payments are essential to avoid negatively impacting your credit score.
Ready for a Line of Credit?
Apply today to enjoy low minimum payments, competitive interest rates, and seamless integration with your chequing account for effortless fund management. With flexible access to funds and straightforward account management, you’ll have greater control over your finances. Discover added convenience along with the standard benefits of a secured or unsecured line of credit.
Apply for a free, No-Fee Bank Account today to get started!