The Differences Between Secured and Unsecured Lines of Credit
Still, all business lines of credit aren’t the same. For instance, there are secured and unsecured lines of credit. Prior to applying, you should be aware of the advantages and disadvantages of both. Deciding on a secured or unsecured line of credit will largely depend on your business’s situation, and we’ll explain other factors to consider in this post.
How Secured and Unsecured Lines of Credit Are Different
- Secured lines of credit have less risks for lenders, which translates to more favorable terms.
- With a secured line of credit, the business owner must provide a valuable asset to lien risks.
The Details: Secured Lines of Credit
A secured line of credit refers to using collateral to “secure” the loan. The collateral can be 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 recoup losses. As such, secured lines of credit are lower-risk for lenders, and thus the interest rates and fees are normally more affordable.
Many of the most common types of loans are secured. For example, a house mortgage is usually secured with the house itself. If the borrower stops making their mortgage payments the bank can seize the home and evict the borrowers. They can then sell the home on the market. Likewise, 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.
Advantages of Secured Line of Credit
- Generally able to secure a higher line of credit.
- Interest rates are usually more affordable.
- Easier for people with subpar credit scores to secure.
Disadvantages of Secured Line of Credit
- 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).
While some borrowers prefer secured lines of credit, it is important to remember that you’re exposing your business or other assets (such as a house) to a lot of risks. In addition, you should carefully review the terms and understand the contract prior to signing.
The Details of Unsecured Lines of Credit
An unsecured line of credit, on the other hand, is not backed by any collateral. This means that the lender must assume 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.
Advantages of Unsecured Lines of Credit
- Risks for recipients are lower, as the creditor can’t place a lien on property.
- No collateral requirements need to be met.
- Unsecured lines of credit are often open-ended, with no end date.
Disadvantages of Unsecured Lines of Credit
- 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.
The most important factor with unsecured lines of credit is that the risks are higher for the lender. As such, your credit score, business’s cash flow, and other factors will be more closely scrutinized. However, the open-ended nature of unsecured lines of credit make them valuable to business owners who are worried that they might face cash crunches.
Conclusion: Both Secured and Unsecured Lines of Credit Are Valuable Tools for Businesses
Whether you should open a secured or unsecured line of credit depends on your business’s situation. If you need open-ended credit in case of future needs, an unsecured line of credit is great to have. Even if you don’t use the credit, it can bring peace of mind knowing that it’s available.
If you’re looking to invest in specific projects, such as buying new equipment, securing the credit may make more sense. Secured lines of credit often aren’t open-ended and are more stringent regarding how it is used. However, interest rates and fees are usually lower. This makes secured lines of credit beneficial for investing in your business.
Before applying, make sure you consider secured and unsecured lines of credit. We hope that this post has helped educate you on both options!
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.