Secured vs. Unsecured Lines of Credit: What’s the Difference?

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Secured vs. Unsecured Lines of Credit: What’s the Difference?

Secured vs. Unsecured Lines of Credit: An Overview

A credit line (LOC) is a revolving loan that may be used for anything. The borrower may draw on the line of credit at any moment, pay it back, and borrow again, up to the lender’s maximum limit.

There are important distinctions between secured and unsecured credit lines, such as the interest rate paid by the borrower.

Key Takeaways

  • A secured line of credit is one that is backed up by collateral, such as a house.
  • A credit card is an example of an unsecured line of credit since it is not secured by any asset.
  • Because it is riskier for lenders, unsecured credit always has higher interest rates.

Investopedia / Lara Antal

What Is a Secured Line of Credit?

When a loan is secured, the lender creates a lien against an asset owned by the borrower. In the case of a default, this asset becomes collateral and may be confiscated or liquidated by the lender. A house mortgage or a vehicle loan are two prominent examples. The bank agrees to lend the money in exchange for collateral, such as a house or a vehicle.

Similarly, a company or person may get a secured line of credit by pledging assets as security. If the borrower fails to repay the loan, the bank may seize and sell the collateral to recover its losses. Because the bank is certain that its money will be returned, a secured line of credit often has a greater credit limit and a substantially lower interest rate than an unsecured line of credit.

The home equity line of credit is a frequent kind of secured LOC (HELOC).A HELOC allows you to borrow money against the equity in your house. 1

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Both secured and unsecured credit lines may have a significant influence on your credit score. In general, if you borrow more than 30% of your available credit, your credit score will suffer. 2

What Is an Unsecured Line of Credit?

A lender takes on more risk when offering an unsecured line of credit. Upon default, none of the borrower’s assets are liable to seizure. Unsurprisingly, unsecured credit lines are more difficult to get for both enterprises and people. 2

Credit cards are basically unsecured loans. That is one of the reasons why their interest rates are so high. If the cardholder fails to make payments, the credit card company has little recourse.

A company could wish to obtain a line of credit to fund its growth, for example. The monies will be returned from future company profits. Such loans are considered only if the firm is well-established and has a good reputation. Even yet, lenders compensate for the additional risk by restricting loan amounts and charging higher interest rates.

Secured Line of Credit vs. Unsecured Line of Credit
Secured LOCUnsecured LOC
Guaranteed by collateralNot guaranteed by an asset
Lower interest rates than for unsecured creditRiskier for lenders, so interest rates are higher
If a borrower defaults, lender can seize collateralNo collateral to seize, so more difficult to get approved by lenders

Should I Choose a Secured or Unsecured Line of Credit?

The decision between a secured and an unsecured line of credit is heavily influenced by the purpose for which you want to use it.

An unsecured line of credit (such as a credit card) may make the most sense for routine expenditures.

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However, if you need to borrow a large sum of money, an unsecured line of credit is typically not the greatest alternative. As previously stated, unsecured credit is riskier for lenders and often carries higher interest rates. Secured credit, on the other hand, is less expensive and simpler to get.

Why Are Interest Rates on Credit Cards So High?

Credit cards are unsecured credit lines. If a cardholder fails, the credit card company has nothing to grab as compensation, which means the interest rates are often quite high.

What Is An Example of a Secured Line of Credit?

A house mortgage or auto loan are two popular examples of secured lines of credit. When a loan is secured, the lender creates a lien against an asset owned by the borrower. In the case of a failure on a mortgage or vehicle loan, the lender may take and liquidate the property.

How Do Secured Credit Cards Work?

A secured credit card is backed by a cash deposit made by the cardholder; the amount of the deposit serves as the credit limit. This deposit serves as collateral on the credit card, providing the card issuer with security in the event that the cardholder is unable to make payments.

The Bottom Line

Lines of credit, both secured and unsecured, provide benefits over other forms of loans. They may be used (or not used) in a flexible and repetitive manner, with minimal minimum payments and no need to pay in full as long as payments are made on time.

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