Pros and Cons of a Secured Line of Credit
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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 type of real estate. 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.
What Are the 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 Are Accepted
Unfortunately, many business owners with poor credit run into challenges when applying for financing. Luckily, there are lower risks associated with secured lines of credit, so lenders will probably be less concerned with your credit score. In fact, one of the main reasons lenders pay so much attention to your credit history is because it indicates your likeliness to repay a loan.
With a secured loan, your collateral 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, your 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 lines of credit, and you may qualify even if you have poor credit history.
3. You Could Receive Longer Loan Repayment Terms
Lower risk not only reduces interest rates – lenders may also offer longer loan repayment terms. Again, this is because of the collateral you can offer to secure the line of credit.
In some cases, lenders will 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.
What Are the Cons of a 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, such as equipment, significant inventory, or invoices. If you lack valuable assets like the ones mentioned, 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 rates. 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. Although it’s helpful to have access to business financing, you don’t want to get stuck with high interest rates.
Conclusion: Secured Lines of Credit Can Be a Great Working Capital Option
As you can see, there are many benefits to secured lines of credit, but also some drawbacks. Ultimately, a secured line of credit could be a great option to consider if you’re interested in business financing, because you’ll have access to capital that you can draw upon. At the same time, you should only take out as much as you need, so that you don’t put your business’s finances at risk.
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.
Editor’s Note: This post was updated for accuracy and comprehensiveness in March 2019.
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.