Pros and Cons of a Secured Line of Credit
A secured line of credit, or any type of “secured” loan for that matter, is tied to a property or asset. For example, one common secured line of credit is a mortgage, which is tied to a house or other property. If the borrower defaults on their mortgage, the lender would be able to repossess the property.
Although a secured line of credit has many benefits, there are also some considerable drawbacks. In this post, we’ll examine the pros and cons of secured lines of credit, so you can determine if this option is right for you.
Pros of a Secured Line of Credit
1. Secured Lines of Credit Usually Have Lower Interest Rates
Perhaps the most important benefit provided by secured loans is that they typically have low interest rates. Lenders calculate risks when setting interest rates; the higher the risks, the higher the interest rate.
Since a secured line of credit is backed by an asset, risks are lowered for the lender. If you default on your line of credit, the lender would sell the repossessed asset to cover their losses. Due to lower risks, lenders can offer more affordable interest rates.
2. Lower Credit Scores Accepted
Since risks are lower with this type of loan, lenders will probably be less concerned with your credit scores. In fact, one of the main reasons lenders pay so much attention to your credit score is because it indicates your likeliness to repay a loan.
With a secured loan, your collateral both lowers risks and increases the likelihood that you’ll make your payments. Since you won’t want to lose the asset tied to your secured line of credit, you’ll likely do your best to repay the loan.
However, credit scores will still impact your loan terms. Lower credit scores indicate higher risk to lenders, so you could have to pay higher interest rates. Regardless, interest rates for secured lines of credit will usually be lower than unsecured credit, and you may qualify even if you have lower credit scores.
3. Longer Loan Repayment Terms
Lower risk not only reduces interest rates, as lenders may also offer longer loan repayment terms. Again, this is because of the collateral you can offer. Lenders will sometimes offer repayment periods up to ten years. Since property is often used to back secured loans, lenders can rely on rising property prices to increase the value of the collateral over time.
Cons of Secured Lines of Credit
1. You’ll Need Valuable Collateral
The benefits that we mentioned above are the result of your loan being secured. However, this means you’ll need valuable collateral to secure your line of credit. Often, this means a home or other piece of valuable property. If you lack valuable assets, you’ll struggle to secure the line of credit.
2. You Could Lose Your Assets!
If you default on your loan, you’ll likely lose the asset tied to your loan. Since you agreed to the terms and offered this asset as collateral, you’ll have little to no legal recourse.
It’s important to note that you’ll need to be careful whenever you use collateral to secure a line of credit. As risks are lowered for your lender, they will increase concurrently for you. When possible, it’s best to use collateral that you can operate your business without.
For example, securing your loan with business property and facilities might be better than using your personal home. After all, if your business goes under, you probably won’t need the business property anymore. However, whether your business succeeds or fails, you’ll need to have a roof over your head!
3. Beware of Variable Interest Rates
Secured lines of credit generally feature lower interest rates, but they’re usually variable rate. This means interest rates could rise, becoming quite burdensome. Make sure you understand the exact terms of your secured line of credit before signing anything.
Conclusion: Secured Lines of Credit Are Among the Best Choices
As you can see, there are many benefits but also some drawbacks to secured lines of credit. Ultimately, a secured line of credit could be a great option for business financing. It’ll grant you access to capital that you can draw upon. At the same time, you should only take out as much as you need.
However, you’ll have to put up valuable assets to secure the credit. This will increase your own risks and you could lose your home or other assets. Make sure you consider these risks when evaluating funding opportunities.
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.