What is the Difference Between Unsecured and Secured Lines of Credit?
Lines of credit can be secured or unsecured. With a secured line of credit, a borrower uses an asset he or she owns as collateral for the loan. If the borrower does not repay the loan, the lender can take the asset that was used as collateral. A home equity line of credit is an example of a secured line of credit. An unsecured line of credit allows the borrower to obtain a line of credit without having to provide collateral. A credit card is an example of an unsecured line of credit. There are advantages and disadvantages to both types of loans.
Collateral and Risk
Lines of credit can be obtained from banks, credit card companies, credit unions, and other lending institutions. Typically, credit line maximum amounts are higher and interest rates are lower for secured lines of credit than for unsecured lines of credit, because the collateral provided on secured credit lines alleviates some of the risk for the lender. Unsecured lines of credit are typically provided at lower amounts because limiting the amount made available to the borrower is a way for the lender to minimize the risk they are taking. Charging higher interest rates are another way that lenders can minimize their risk.
In addition to having a higher maximum amount and a lower interest rate, secured loans are usually also easier to qualify for. Because assets are being used to secure the loan, more flexibility can be allowed when considering the borrower’s credit report when determining whether to approve the loan. However, for secured lines of credit, the borrower must have assets to use as collateral. Assets typically accepted by lenders include vehicles, homes, savings, and investments. If the borrower does not pay the loan timely in accordance with the terms established in the loan agreement, the lender can seize the assets provided as collateral. If a borrower does not own any assets to put up as collateral, they will not be able to qualify for a secured loan.
As mentioned, unsecured lines of credit from traditional lending institutions usually have lower maximum amounts and higher interest rates. They may be the best option for borrowers who do not have collateral that they can offer to secure a loan. Without taking collateral, a lender will rely more heavily on the borrower’s income and credit history to determine qualification. A borrower with no credit history or with poor credit may have difficulty being approved for an unsecured line of credit from a traditional lender.
High-Risk Borrowers with No Collateral
Borrowers with less-than-perfect credit may not be out of luck, though. Other lenders exist outside of traditional banks and credit unions who offer unsecured lines of credit. These types of lines of credit may be for amounts even lower than the limits of unsecured credit lines from banks, and typically these lenders primarily look at proof of regular income above a minimal amount for qualification. Interested borrowers can learn more about these types of personal lines of credit at our FAQ page.
When determining whether to obtain a secured or unsecured line of credit, borrowers must understand their needs and assess their ability to meet the repayment obligations of entering a loan agreement. A smaller loan amount not requiring collateral may be more beneficial to some borrowers; whereas, other borrowers may need to borrow larger amounts and need to obtain a secured loan. Regardless of the option chosen, all borrowers should ensure they understand the loan terms before entering into the loan agreement and ensure they have the means and ability to timely repay the loan. Responsible borrowing is an important part of building a strong financial future.
The content on this site is for informational purposes only and is not professional financial advice. Ladder Credit does not assume responsibility for advice given. All advice should be weighed against your own abilities and circumstances and applied accordingly. It is up to the reader to determine if advice is safe and suitable for their own situation.