Do you have unanticipated expenses and a shortfall of funds? Are you dealing with any emergency that is difficult to budget for?
Well, if you’re in this situation, taking out a line of credit may be more beneficial than borrowing a personal loan or payday loan that gives you funds in one lump sum.
The line of credit essentially allows you to access a set amount of funds. You take out only what you need from your fund. The lender charges interest for the funds that have been utilized. It gives you constant and immediate access to credit, and there are no restrictions whatsoever on how you use the money.
There are two major types of lines of credit: secured vs. unsecured line of credit. This article covers their pros, cons, definitions, examples, and more.
What is a secured line of credit?
Lending out money involves taking a huge risk. The lender has to have trust and faith that the borrower will abide by the terms of the loan agreement that stipulates the monthly payments, the interest charged, and the repayment schedule.
It’s not unusual that most lenders want to reduce the risk they take when issuing credit lines. One way of minimizing this risk is by asking the borrower to secure the loan with their personal property.
Therefore, a secured line of credit, by definition, is any line of credit where the lender requires collateral from the borrower.
If the credit line does not expire and the lender allows the customer to borrow again once they have paid off their outstanding balance, the credit facility may be referred to as a revolving line of credit.
Which types of personal property can be used to secure a line of credit?
There are multiple types of properties you can use as collateral in Canada. Some of the assets used for personal LOCs include:
- Real estate
- Jewelry, art, antiques, and other valuable items.
- Bank accounts: savings and checking accounts
- The equity built up while paying off a mortgage
- Investments: stocks, securities, etc
Note that: If you are searching for a business line of credit, the types of assets that may be used as security will differ as well. Businesses can use the following assets:
Inventory – items held in stock that can be sold
Business savings account
Vehicles owned by the business
Buildings, undeveloped land, and home equity
Money still owed by customers – accounts receivable
Personal assets belonging to the owners of the business
Stocks, bonds, mutual funds, etc.
What happens if the borrower can’t repay a secured line of credit?
The lender has every right to take possession of the item that was used as collateral. They may choose to sell the assets or lease to obtain the outstanding loan amount.
All the measures and situations in which the lender can exercise their powers will be stipulated in the loan agreement. Similarly, the agreement should specify scenarios in which the loan will be considered to have defaulted. Most lenders will take the borrower to the courts before choosing to repossess the asset.
Examples of a secured line of credit
Home equity line of credit (HELOC): It’s similar to a home equity loan in that it uses the property as security. Some lenders even allow you to convert a HELOC to a home equity loan.
In most cases, the HELOC should not exceed more than 65% of the property’s value. The funds are not offered up front, but you withdraw what you need with the interest rate calculated daily. Most HELOCs allow customers to make interest-only payments.
Secured credit cards: They are popularly used by inexperienced borrowers who want to build up a credit history. The security used is a cash deposit. It’s usually equal to the credit facility amount.
Car title loans: In most instances, taking out a car title loan means that you will receive the funds in one lump sum payment. But if you receive a line of credit instead, the car title loan may as well function as a secured line of credit.
Secured business line of credit: Most banks offer LOCs to small businesses. The business has to deposit some funds as security.
Pros vs. cons of a secured line of credit
|May have a higher credit limit than unsecured LOC||The lender has every right to repossess property on failure to repay|
|Consumers with lower credit scores can increase their borrowing limit||The borrower needs to own valuable assets, which may discriminate many from borrowing|
|The interest rate is considerably lower because of decreased risk||Secured HELOCs with interest-only payments may be troublesome once the principal payments begin|
|The lender may be more inclined to lend to you if you can secure the loan||Without proper planning, some borrowers may lack the discipline to manage the LOC properly|
What is an unsecured line of credit?
Many lenders don’t require customers to offer personal assets as security for advance credit. The borrower just needs to provide certain information to the lender, including:
- Income amount – It helps the lender determine if you can manage the interest and principal payments of the amount you want to borrow
- Credit history – Lenders look at how you repaid previous debts to determine if you can handle a new LOC. Information about your previous credit lines is documented in your credit reports.
- Credit score range – The credit score is calculated from your past borrowing information to act as a quick snapshot of your prior credit history. The score ranges from 300 to 900 in Canada. Having a score of 619 and below means, you have a poor credit rating. And it makes it difficult to obtain funds from traditional institutions.
What is the formal unsecured line of credit definition? Well, it’s any LOC that you can borrow without providing collateral.
What happens if I can’t repay an unsecured line of credit?
The creditor, in this case, cannot take possession of your personal assets. But since you had a contract with them and stipulated that you will honor the terms of the loan agreement, they can take you to court. They will seek a judgment against you and have your wages garnished or place a lien on your property.
What are some examples of an unsecured line of credit?
Many of the LOCs you encounter are unsecured. Credit cards are essentially the most common types of unsecured revolving credit.
So what is the difference between a secured and unsecured line of credit?
They are different in several respects:
If you default: The lender can seize your property with a secured line of credit. To a certain degree, your assets are protected from creditors but are still at risk if the debtor wins a debt collection lawsuit.
Interest rates and amounts: In a low-risk environment, lenders are willing to lend more and at a cheaper rate in secured lines of credit.
What are the pros and cons of unsecured lines of credit?
|The lender can’t automatically repossess assets upon default||May require more creditworthiness to qualify|
|Borrowers can use their assets freely with no restrictions such as banking accounts||With the tough requirements, many people may not qualify|
|It’s easier to apply without the intricate procedure of giving lenders access to assets||The interest rates may be higher|
|It’s possible to qualify even with bad credit||The lender may offer a lower credit limit|
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