What is the Difference Between a Secured and Unsecured Line of Credit?


Lines of credit (“LOC”) can be a useful source of funds; especially when a large sum of money is required. Unlike a conventional loan, you do not need to make a payment on a LOC until the credit line is used. Besides, they have built-in flexibility that allows borrowers to request a given amount of money but only use the amount they need. Applicants can repay the funds in whole or adjust the repayment amounts as they wish depending on their cash flow. Most importantly, borrowers can choose between a secured or unsecured line of credit depending on their current situation. Careful consideration is required when choosing between the two since each has its own advantages and disadvantages.

Unsecured Line of Credit

An unsecured LOC is a loan advanced without requiring the borrower to provide collateral to the lender. Most lenders rely on trust when lending out credit without any form of security. An unwritten law is that lenders also check the credit score of the borrower before imposing a cap on the amount a borrower can get. These are great loans to consider in times of urgency as there is generally less paperwork to fill out. Although they are easier to get, the interest rate of unsecured loans is usually higher than that of secured loans.

When to Apply for an Unsecured Line of Credit

Someone may choose an unsecured LOC if they need money but have other investments that they do not want to cash out at that given time. For instance, a person with an uneven cash flow may opt for these loans rather than cashing out a bond. Another instance would be when one wants to buy a house before the process of selling his previous home is finalized. As long as there is an imminent need for cash such as when needing to cover a small expense, an unsecured LOC can be useful. On the other hand, it is not advisable to take out an unsecured LOC to settle large bills such as student loan debt due to the uncertainties involved.

Secured Lines of Credit

As the name suggests, a secured LOC is a loan that is advanced after the borrower provides some form of collateral to the lender. This collateral could be a valuable asset that can be sold to recover the loan if the borrower defaults.  Businesses also seek secured LOCs and use property or equity as their collateral. The security used for a secured LOC can help applicants access a higher amount of credit than would be possible with an unsecured LOC. However, their main drawback is the paperwork generally takes longer before the loan is approved. It is wise to only seek a secured LOC if the project at hand requires a larger amount of money. However, borrowers generally benefit from lower interest rates than with an unsecured LOC.

When to Apply for a Secured Line of Credit

Since these loans attract lower interest rates, they can be useful when needing to pay off existing, but urgent loans. Secured LOCs also offer a good solution for consolidating several loans into one. Businesses can take advantage of the higher sums available to buy equipment and repay with time. Additionally, a secured LOC is cyclic, so applicants can take successive loans without having to reapply. A good practice is to shop around before applying for a line of credit as rates and the terms of service differ from one lender to the other.