Introduction 

A line of credit (LOC) is an open-ended loan which can have multiple uses. It is a kind of revolving loan that is somewhat similar to a credit card. The customer can use the line of credit multiple times and pay the money back on an ongoing basis. It does have a maximum limit but there is no fixed expiration date. Lines of credit can be secured or unsecured, and there are significant differences between the two.

What is Secured Line of Credit?

A secured line of credit refers to using collateral to “secure” the loan. The collateral can get seized in the event of a default. If you fail to make payments, the lender can put a lien on the collateral and legally acquire it. They can then sell the collateral to recover losses. As such, secured lines of credit are lower-risk for lenders, and thus the interest rates and fees are normally more affordable.

Most common types of loans are secured. For example, a home loan is usually secured with the house itself. If the borrower stops making their EMI payments the bank can seize the home and evict the borrowers. They can then sell the home on the market. Similarly, a car loan is secured with the car itself. Both home and auto loans are among the lower interest rate loans because they are backed by high-value collateral.

Key Benefits:

  • Generally able to secure a higher line of credit.

  • Interest rates are usually more affordable.

  • Easier for people with subpar credit scores to secure.

Important Points to Consider:

  • Must have valuable assets to use as collateral.

  • Higher lines of credit increase risk of being buried in debt.

  • Higher risks for borrowers that don’t pay (collateral will be seized).

Common Types Secured Lines of Credit:

  • Home Loan – A mortgage is a loan to pay for a home. Your monthly mortgage payments will consist of the principal and interest, plus taxes and insurance.

  • Home Equity Line of Credit – A home equity loan or line of credit (HELOC) allows you to borrow money using your home’s equity as collateral.

  • Auto Loan – An auto loan is an auto financing option you can obtain through the dealer, a bank, or credit union.

What is Unsecured Line of Credit?

An unsecured line of credit is not backed by any collateral. This means that the lender takes on a high level of risk. If the borrower stops making payments, the lender has fewer options for recovering losses. However, the lender will have legal recourse. For example, they can hire a debt collector or try to sue the borrower in court. They can also report defaulted debts and delinquent payments to credit bureaus. 

Key Benefits:

  • Risks for recipients are lower, as the creditor can’t place a lien on the property.

  • No collateral requirements need to be met.

  • Unsecured lines of credit are often open-ended, with no end date.

Important Points to Note: 

  • Interest rates and fees are usually higher.

  • The total amount that can be borrowed is usually lower.

  • Unsecured lines of credit are often harder to obtain.

Common Types of Unsecured Lines of Credit:

  • Credit Cards – There are different types of credit cards, but general credit cards bill once a month and charge interest if you do not pay the balance in full.

  • Personal Loans – These loans can be used for many purposes, and can vary from a few hundred to tens of thousands of dollars.

  • Student Loans – Student loans are used to pay for college and are available through both the Department of Education and private lenders. Although it is an unsecured loan, tax returns can be garnished to pay unpaid student loans.

  • Home Improvement Loans

Secured v/s Unsecured Line of Credit – What are the Key Differences?

  • The main difference between a secured and unsecured line of credit is the collateral required to attain the loan. A secured line of credit requires you to provide the lender with an asset that will be used as collateral for the loan. Whereas an unsecured line of credit doesn’t require you to provide an asset as collateral in order to attain a loan.

  • Another key difference between a secured and unsecured loan is the rate of interest. Secured loans usually have a lower rate of interest as compared to an unsecured loan. This is because unsecured loans are considered to be riskier loans by lenders than secured loans.

  • Secured loans are easier to obtain while unsecured loans are harder to obtain, as it is less risky for a banker to dispense a secured loan.

  • Secured loans tend to have longer repayment periods when compared to unsecured loans. In general, secured loans offer a borrower a more desirable contract that an unsecured loan would.

Additional Reading: Secured Loan and Unsecured Loan in India

FAQs

  1. Is a Secured Loan Better than an Unsecured Loan?

A secured loan is usually more favourable for a borrower than an unsecured loan. The repayment periods are a lot longer, the interest rates are lesser, and borrowing limits are higher when it comes to secured lines of credit. All these factors imply that opting for a secured loan is more beneficial for a borrower.

  1. What are the examples of an unsecured loan?

Some of the common types of unsecured lines of credit include credit cards, personal loans, and student loans.

  1. What are some of the secured lines of credit available in the market?

Some of the common secured lines of credit available today include home loan, car loan, and even home equity line of credit. 

End Note

A secured line of credit may be a good idea if you have an asset like a home or car that you’re willing to pledge and are confident you’ll be able to pay back your loan. Before you take out any line of credit, make sure the monthly payments will fit into your budget so you don’t get in a financial jam.