Secured vs. Unsecured Lines of Credit: What You Should Know
A line of credit is any credit source that a lender or financier provides to you. It may be a credit card, a personal loan, a mortgage, or even a working capital loan for a small business. Some lines of credit are secured, and others are unsecured. Here are the differences and what everyone needs to know about them before borrowing.
Understanding Unsecured Credit
By far, the most popular type of credit line in the UK and around the world is unsecured credit. This is any line of credit provided in good faith and without collateral as a guarantee. There are many different types of unsecured credit lines, including:
- Credit cards;
- Personal loans;
- Lines of credit;
- Signature loans;
- Student loans;
- Small business loans;
- Working capital loans; and
- Short-term (payday) loans.
To obtain unsecured credit, borrowers must often have good to excellent credit. This is because the lender takes on some risk when issuing lines of credit without any form of collateral. Your credit history will play an important role in determining the amount of money you may receive and even the interest rate associated with your loan. The higher your credit score, the more money you can receive and the lower the interest rates.
Types of Secured Credit
Secured credit is any extension of credit or a loan that is guaranteed by property, whether that property is a car, a house, or even an expensive piece of jewellery. The most popular types of secured credit lines include:
- Home loans (mortgages);
- Auto loans;
- Business equipment loans;
- Certain credit cards;
- Personal loans; and
- Logbook loans.
There are some benefits associated with secured credit, too. If you can put up collateral, lenders are often more lenient when it comes to qualifying you for a loan based on your credit history. The collateral helps the lender mitigate its risk in lending; if the borrower defaults, the lender can take possession of the property and sell it to recoup any losses it experiences. Larger secured loans – such as mortgages and new car loans – will still require an excellent credit rating based on their size.
Which Type of Credit Best Suits Your Needs?
If you need a loan, it’s important to take a look at your unique financial situation. Your credit history will ultimately determine whether you can qualify for an unsecured loan, and it will also dictate the amount of that loan as well as the interest associated with it. In the case of a mortgage or large auto loan, your credit history is still a very important deciding factor. If your credit is less-than-perfect, you will likely have a difficult time qualifying for most unsecured lines of credit.
On the other hand, if you have valuable property, lenders will often relax their credit requirements somewhat. If you have a lower credit score, but your car has some value, then you can enquire about a logbook loan. If you’re still building your credit and you have money in a savings account, a lender may agree to provide you with a credit card as long as your monthly payments are automatically drafted directly from that savings account each month. These things reduce the lender’s risk, thereby improving your odds of approval.
The differences between secured and unsecured credit are simple, but deciding which type of loan will ultimately suit your needs can be a bit of a challenge. Unsecured credit is typically only available to people who have excellent credit ratings, but if you have less-than-perfect credit, or if you are still building your credit, then a secured loan is a great starting place – and it can help you improve your score, too.