Credit cards and personal loans aren’t the only way to access the cash you need. A secured line of credit could also be an option, but maybe you’re unsure how it works. In this guide, you’ll learn what to expect when you open a secured line of credit, along with the key benefits and drawbacks it offers, eligibility criteria and other alternatives worth considering.
How A Secured Line of Credit Works
As the name suggests, a secured personal line of credit is a debt product backed by collateral. Common assets used for security include vehicles, homes, boats or other valuables.
You can apply for a secured line of credit through traditional banks, credit unions or online lenders. If approved, you’ll have access to a pool of funds you can draw from, typically through a lender-issued debit card or check. There’s also the option to deposit the money directly into your checking or savings account each time you make a withdrawal if you already do business with the financial institution.
There’s no obligation to use the entire amount, and you’re free to repay and reuse the funds as often as you like during the draw period. Plus, you’ll only pay interest on the amount you use.
Benefits of a Secured Line of Credit
Secured lines of credit offer an assortment of benefits to account holders.
Lower Interest Rates
Since these debt products pose less of a risk to lenders, you could receive a lower interest rate than you would with a credit card or loan designed for consumers with less-than-perfect credit. This can be particularly beneficial if you’re trying to consolidate high-interest debt or if you need to borrow a large amount of money.
Ease Cash Flow
Cash flow issues can mean bad news for your finances and credit health. But with a secured line of credit, you’ll have access to a pool of cash that you can pull from any time money’s running low. This can help you avoid late fees, penalties, and other financial consequences of missed payments.
Lower Credit Scores May Be Accepted
You don’t need good or excellent credit to qualify for a secured line of credit. In fact, it’s highly likely that you’ll get approved if the asset you use as security holds substantial value. So, if you’re struggling to get approved for other types of loans due to past credit missteps, you could be in luck.
Longer Loan Repayment Terms
Most secured lines of credit come with extended repayment periods. This beats payday loans and other expensive forms of credit that only give you a few weeks or months to repay what you borrow. It can also be a significant advantage if you need to borrow a large amount of money or if you need more time to repay what you borrow. With a secured line of credit, you can typically repay and reuse the funds as often as you like during the draw period, which can span several years.
Drawbacks of a Secured Line of Credit
Unfortunately, there are also cons of a secured line of credit to keep in mind.
Necessity Of a Collateral
You won’t get approved for a secured line of collateral without putting up collateral as security. This makes these loan products inaccessible to consumers without assets.
Risk Of Asset Loss
If life happens and you fall behind on loan payments, you could lose the asset you put up as collateral if the lender seizes it to recoup what they’re owed.
Variable Interest Rates
Depending on market conditions, you will likely get a variable interest rate, which means your borrowing costs could be high or low. Monthly loan payments will also vary over time.
Potential Impact on Your Credit Score
If you fall behind on loan payments or default on the loan, your credit score can be negatively impacted. Unfortunately, it can also become more challenging to qualify for credit products in the future. And if you are approved, you’ll likely get unfavorable terms and higher interest rates.
How To Qualify for a Secured Line of Credit
To increase your approval odds, you should meet the following criteria:
- Have an asset with substantial value: One of the most important factors that lenders will consider when evaluating your eligibility for a secured line of credit is the value of the collateral you are using to secure the loan. It can be any asset with substantial value, such as a home, vehicle, boat or other valuable property. The lender will evaluate the value of the collateral and use this information to determine the amount of your credit line.
- Have the means to repay what you have borrowed: Lenders also evaluate your ability to repay the loan. This means that you will need to demonstrate that you have the means to repay what you have borrowed. Prepare to provide information about your income, employment history and assets. Lenders will also evaluate your debt-to-income (DTI) ratio, which is a measure of your monthly debt payments compared to your monthly income. A lower debt-to-income ratio can increase your chances of approval for a secured line of credit.
- Meet the lender’s minimum credit score requirement (if any): Another factor that lenders may consider when evaluating your eligibility for a secured line of credit is your credit score. Why so? Your credit score is a measure of your creditworthiness and your ability to manage debt responsibly. If you have a low credit score, you may still be able to qualify for a secured line of credit but will likely get a higher interest rate.
Alternatives To a Secured Line of Credit
Perhaps you’re thinking about looking beyond a secured line of credit to meet your funding needs. In that case, there are other options available, including:
- Unsecured personal line of credit: Unsecured personal lines of credit can be an attractive option for borrowers with good or excellent credit scores. With an unsecured line of credit, you won’t need to put up collateral to secure the loan, which means your assets won’t be at risk of seizure if you experience financial hardship and fall behind on loan payments. Furthermore, borrowers with good or excellent credit scores may be able to qualify for better terms and lower interest rates than they would with a secured line of credit. However, it’s important to note that unsecured lines of credit may be more difficult to qualify for than secured lines of credit and may come with higher interest rates and fees.
- Secured credit card: Secured cards are ideal for borrowers who are looking to build or rebuild their credit. These cards work like traditional credit cards but require a security deposit that’s generally equivalent to the credit limit to open an account. By using a secured credit card responsibly and making on-time payments, you can establish a positive credit history and improve your credit score over time. Furthermore, if you have a solid credit rating, you may qualify for a balance transfer card that offers a zero-percent APR of up to 18 months, which can be a valuable tool for consolidating high-interest debt and saving money on interest charges.
- Personal loan: Personal loans can be a useful tool for accessing the funds you need to cover unexpected expenses or to consolidate high-interest debt. These loans are available to consumers with varying credit ratings, but borrowers with lower credit scores may be subject to higher interest rates and fees. With a personal loan, you’ll receive the loan proceeds in a lump sum and make equal monthly payments over a fixed period of time. It’s important to note that interest is payable on the entire loan amount, even if you spend a portion of what you borrow. Consequently, it’s important to carefully consider your borrowing needs and repayment ability before you apply for a personal loan.
- Home equity line of credit (HELOC): This type of loan allows you to borrow against the equity in your home. HELOCs typically have lower interest rates than other types of loans, but they also come with the risk of losing your home if you can’t make your loan payments.
- Business line of credit: If you’re a business owner, you may also be able to obtain a business line of credit. They are designed to help businesses manage cash flow and cover unexpected expenses. Business lines of credit generally have higher credit limits than personal lines of credit, but qualifying may be a bit more challenging. If your credit score is low, you may have a better chance of qualifying for a secured business line. Either way, you’ll need to have a solid business plan and a good credit history to qualify for a business line of credit.
The Bottom Line
A secured line of credit can be a great tool for accessing funds when you need them. By using your asset as collateral to secure the loan, you may be able to qualify for a larger amount of credit or a lower interest rate than you would with an unsecured loan. However, it’s important to carefully consider the risks and drawbacks of a secured line of credit before you apply.
You’ll need to have an asset with substantial value to use as collateral, and you’ll need to demonstrate that you have the means to repay the loan. It’s also vital to carefully manage the credit line to avoid defaulting and forfeiting your collateral.
If you’re considering a secured line of credit, be sure to shop around and compare offers from multiple lenders to find the best terms and rates. If you’re not sure whether a secured line of credit is the right choice for you, consider speaking with a financial or credit counselor to get personalized guidance based on your individual needs and goals.
With careful planning and responsible borrowing, a secured line of credit can be a valuable tool for managing your finances and achieving your financial goals.
