A line of credit is when a financial institution, usually a bank, sets a borrowing limit which can be used at any time by the individual. So, you are free to pull out money at any time as long as it is within the set limit and repay as you can. You can borrow from this chunk again as and when required.
The amount of interest to be paid, the size and number of installments are all set by the lender. While some lines of credit allow you to write checks, others give you some sort of a credit or debit card. These can either be secured or unsecured in nature wherein the unsecured ones are more susceptible to higher interest rates.
The innate quality of these lines of credit is the flexibility. You can apply to get a certain amount but you have to pay only the amount that you use and the interest rate applicable to that amount. In addition, borrowers can adjust the repayment amount depending on the funds they have in hand. So, you can choose to repay all the amount in one go or pay in installments.
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Secured Line of Credit
A secured line of credit has a collateral which secures the loan which means that it can be seized by the lending institution if the loan is not paid within the specified time frame. Another option is to sell the collateral with which the bank can recover the loss incurred. Since these lines of credit are a secure offering for the banks, the interest rates charged and other processing fees are affordable.
Most of the loan types are secured like a home loan holds the home itself as a collateral and the same applies to a car loan as well. In case the borrower fails to make timely repayments, then the bank has the right to evict the borrower and seize the house.
The benefits of opting for a secured line of credit are:
- You can secure a higher line of credit
- Affordable interest rates
- People with an average credit score can also secure these loans
To go for these lines of credit, the borrower must ensure that they have valuable assets that can be used as a collateral.
Unsecured Line of Credit
These loans expose lenders to a higher level of risk since there is no collateral that is required for these loans. In case the borrower stops repaying the loan, lenders can only opt for a legal course of action to sue the borrower or report the failed payments to the credit bureaus and bring down the credit score. Interest rates for these are higher than secured lines of credit and the amount that can be borrowed is lower due to that.
The key benefits of opting for these lines of credit are:
- You have a lower risk exposure as the lender cannot seize anything from you
- There is no collateral required
- These lines of credit are open ended or without an end date
Personal loans, credit cards and student loans are a few examples of unsecured loans.
Difference between them
The first and most evident difference between secured and unsecured lines of credit is the collateral. You would need to place a collateral in case of a secured loan but in case of an unsecured loan, you would not need any collateral.
Due to the above difference, the interest rates also differ greatly in the two. Since the lender is at a higher risk while giving unsecured loans, their rates of interest are higher. Since the risk is higher in unsecured loans, they are harder to obtain without a good credit score. So, make sure you have a strong credit score in order to pick up a personal loan, credit card or student loan.