Planning a major home renovation this year but unsure how much funding you’ll need and when? A line of credit might be the best financing option, providing flexibility and easy access to cash when you need it. If you've never heard of a line of credit before, do not worry, we can help with that.

A line of credit (LOC) is a flexible type of borrowing that allows you to borrow a certain amount of money, up to a pre-approved limit, and you can borrow money without receiving the entire payment at the beginning. To make it simple for you to understand, think of it like a credit card. You can borrow cash and as long as you go under your credit limit, then you can take out cash, then repay and borrow again. The benefit of this type of credit is that you only pay interest on the amount you borrow, not the limit you are approved for.

There are two types of lines of credit and they are secured and unsecured. Understanding the differences between secured lines of credit and unsecured lines of credit will allow you to better plan ahead for your line of credit and apply early, so you are ready to access your funds when you need it. We will explain all of this to help you determine which type of line of credit makes the most sense for you depending on your needs.

Discover more: How To Get a Line of Credit With Bad Credit

What is a Secured Line of Credit?

A secured line of credit is also a flexible type of borrowing, but this borrowing is attached to collateral (your home, car, savings). Essentially because you use collateral as a guarantee, lenders will approve you with better interest rates, and higher limits. A secured line of credit is a smart way to utilize your funds when you need them, on your terms.

There is a downside to secured borrowing, if you stop making payments on your line of credit, the lending institution has the right to take the assets that you provided as collateral. Yes, a secured line of credit has a lot of benefits, but you must utilize the line of credit wisely to make sure you can pay it back in a timely manner.

What is an Unsecured Line of Credit?

An unsecured line of credit gives you access to funds without requiring collateral. An unsecured line of credit is based solely on your creditworthiness which you may be more comfortable with if you have a strong credit history. Unsecured lines of credit are flexible and convenient and will often be used for emergencies, home projects or managing cash flow.

Using an unsecured line of credit allows you to borrow as you need, and then repay and re-borrow cash, similar to how you would use a credit card. However, since there is no collateral, interest rates are usually higher and limits are lower. An unsecured line of credit is an excellent tool if you need something for flexible spending, but you need to utilize it responsibly to not fall victim to traps with debt.

Key Differences Between Secured and Unsecured Lines of Credit

Now, let’s dive into the key differences between secured and unsecured lines of credit. This thorough comparison will help clarify how each option works and which one is the best choice for your financial goals.

Collateral

Secured Line of Credit:

A secured line of credit requires you to provide an asset that can be leveraged, such as your home, vehicle, or savings account, to be used as collateral. This gives the lender some assurance and is generally the least difficult to get approved for.

Unsecured Line of Credit:

An unsecured line of credit does not require any collateral, and the lender will be using your creditworthiness for approvals. If you do not have any valuable assets, this option is a good option.

Interest Rates

Secured Line of Credit:

Since secured lines of credit require collateral, they generally include a lower interest rate because the collateral reduces the risk to the lender. This can really add up in savings, especially with larger loans and longer lengths of borrowing.

Unsecured Line of Credit:

Unsecured lines of credit have higher interest rates because there is more risk to the lender, making them an expensive option when compared to secured lines of credit.

Approval Criteria

Secured Line of Credit:

It is often easier to get approved for a secured line of credit if you have a valuable asset, even with bad credit. Lenders like security, and have more flexibility on the lending front, because now they have something that they can leverage for the loan.

Unsecured Line of Credit:

Conversely, unsecured lines of credit require good credit, stable income and a favorable financial position as there's no guarantee that the borrower will repay the loan. Hence, the approval criteria are comparatively tough.

Risk to Borrower

Secured Line of Credit:

The biggest risk that a borrower faces regarding a secured line of credit is that they are at risk of losing their pledged asset if they default on the loan. As a result, there could be foreclosure or even asset repurchase depending on the collateral.

Unsecured Line of Credit:

In the case of an unsecured line of credit, the borrower doesn't have this risk of losing their property, but late and missed payments can significantly damage their credit score and limit their ability to borrow in the future.

Credit Limit

Secured Line of Credit:

Secured lines of credit will often provide a much higher credit limit because secured credit is tied to one of your valuable assets. They are ideal if the borrower needs access to a large sum of money.

Unsecured Line of Credit:

In contrast, unsecured lines of credit will often have lower limits because unsecured lending relies on determining how much credit can be extended to a borrower based only on the borrower's income and credit.

Processing Time

Secured Line of Credit:

Secured lines of credit can take longer to process because after the borrower applies for the credit, the lender needs to evaluate the collateral that the borrower is pledging. This step can add time until the borrower can receive funding.

Unsecured Line of Credit:

Generally, unsecured lines of credit can be approved and funded quickly. Most lenders will provide funding on the same day the applicant completes the application and provides the needed documents. Unsecured lines of credit are sometimes the best option if the borrower has a specific time-sensitive want or need for money.

Repayment Terms

Secured Line of Credit:

Generally, secured lines of credit provide easier repayment terms with longer repayment agreements and lower monthly payment requirements. Because of this, secured lines of credit can be easier to manage for borrowers, especially for large expenses or recurring costs.

Unsecured Line of Credit:

Conversely, unsecured lines of credit generally have a shorter repayment term and higher monthly payments to pay off the debt. Hence, an unsecured line of credit could be tougher on the budget.

Discover more: 7 Tips on How To Use Your Line of Credit Wisely

Common Examples

Secured Line of Credit:

Common secured lines of credit include home equity lines (HELOCs) and asset-backed business credit lines. These types of lines of credit are usually used to fund large projects or investment needs.

Unsecured Line of Credit:

Common unsecured lines of credit consist of personal lines of credit, credit cards, and unsecured small business loans. Unsecured lines of credit are usually used for short-term expenses and emergencies.

Discover more: Line of Credit vs. Credit Card: Difference, Pros and Cons & More

Best For

Secured Line of Credit:

Due to the nature of secured lines of credit, they're best for a borrower with valuable property and need more borrowing power than what would have been otherwise available at a lower interest rate. In addition, secured lines of credit are ideal for long-term financial needs like renovations or expanding a business.

Unsecured Line of Credit:

Unsecured lines of credit are best for anyone with excellent credit. However, some lenders also offer unsecured lines of credit to those with low credit and are looking for quick, easy, short-term borrowing without having to provide collateral or tied up personal assets.

Which Type of Line of Credit Is Right for You?

Whether you choose a secured or unsecured line of credit will depend on your financial goals, credit history, and the comfort level you have with taking on risk. You should consider how much you need, whether you can provide collateral, and how urgently you need access to cash. You also can look at some factors to see how many lines of credit you can have opened at any given time while making this decision.

Each option has its benefits and drawbacks so understanding your current financial position will help you make the right decision.

When to Opt for a Secured Line of Credit?

A secured line of credit can be a good choice if you require a larger credit limit and have available collateral like your home, vehicle, or other assets of value. Due to its secured nature, this type of credit line usually has lower interest rates and can offer more flexible repayment terms. For these reasons, a secured line of credit could be a good option for longer-term expenses like home renovations or business expansion.

Keep in mind that failure to make payments means that the lender has a legal claim to your asset purchased with borrowed funds. While it may be easier to qualify for a secured line of credit - even with fair credit - the risk to your assets means that secured lines should be considered with caution and only when you are reasonably sure that you will be able to repay them.

When to Opt for an Unsecured Line of Credit?

An unsecured line of credit is ideal if you require rapid access to cash and/or only need smaller amounts of cash. Unsecured lines of credit are also the most common way to deal with emergencies, day-to-day expenses, or any short-term financial gap you may have to deal with. Because there's no collateral required, you can just focus on meeting the terms of the repayment without worrying about your asset.

However, the qualification requirements are generally stricter. You will need a stronger credit score, a reliable source of income, and a considerable level of financial history to qualify for an unsecured line of credit. The interest rates will be higher and the borrowing limits lower when compared to a secured line of credit. However, unsecured lines of credit are great when you qualify and need short-term access to funds without having to put your personal property on the line.

The Final Word

Both secured and unsecured lines of credit provide valuable financial flexibility, but which one is best for you is highly dependent on your particular situation. If you have valuable tangible or intangible assets and want the benefit of securing lower rates, selecting a secured line of credit is best. If you prefer the flexibility to borrow the amount without risking ownership of any important asset, selecting unsecured is the best option.

Having a sound understanding of the differences, pros, and cons of both types of line of credit will ensure that you can borrow responsibly. Carefully reviewing your needs, financial stability, and whether you can repay long-term obligations will further allow you to make a better choice to maximize your financial abilities.