What is a secured line of credit?

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In a Nutshell

If you want to borrow money with a secured line of credit, first consider if you’re willing to risk an asset in exchange for a potentially lower interest rate. You’ll also want to examine potential fees and additional costs before deciding if this type of borrowing is right for you.
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If you’ve got recurring expenses or several large purchases to make and don’t want to use a credit card, a secured personal line of credit may be a good option for you.

When a lender approves you for a line of credit, you’re given a set amount of money that you can borrow against as needed, which is similar to a credit card. You’ll pay interest as you spend money, too.

A secured line of credit means you’re promising an asset like real estate or a savings account as collateral in case you don’t pay back what you owe.

With an unsecured line of credit, you don’t have to put down an asset as collateral to secure the loan. Since your assets can’t be taken away upon default, your lender’s risk is typically greater than with a secured line of credit. And personal lines of credit are often unsecured.

Pros of a secured line of credit

  • You may get a lower interest rate. Since a secured line of credit is backed by an asset, lenders often consider their risk lower — possibly resulting in lower interest rates.
  • You can access money continually. Instead of receiving a lump sum of money like a personal loan, a secured line of credit gives you access to a set amount of money that you can borrow for a set period of time, or draw period — usually about several years long. And you don’t pay any interest until you actually borrow.
  • You have flexibility for large expenses. If you want to tackle home improvements, a secured line of credit like a home equity line of credit can be a good option if you want to complete renovations in phases. For example, if you want to renovate your kitchen and master bedroom but aren’t sure how much it will cost, a HELOC can let you draw money for the projects up to the credit limit, which can help ensure you don’t borrow more than you need. That can be better than a home equity loan in which you get the money in a lump sum.

Cons of a secured line of credit

  • You may lose your asset. If you can’t pay back your lender, you may lose the asset you secured the credit line with — whether that’s your house, car or some other valuable. If you’re OK with that risk, consider setting up an emergency fund in case you become unemployed or take some other financial hit.
  • You may spend money you don’t have. It can be a little too tempting — and easy — to dip into your line of credit for everyday expenses, which can add up fast and leave you with much more to pay off than you planned. So be careful with how often you pull from your line of credit if you’re approved.
  • You may pay extra fees. Secured lines of credit can include fees like annual fees, transaction fees and closing costs in addition to interest. Make sure to include those potential costs in your budget when you’re exploring a secured line of credit.

Types of secured lines of credit

Depending on your circumstances and what you need the money for, there are different kinds of secured lines of credit to consider. 

  • Home equity line of credit: A HELOC is backed by your home’s equity and your property is the collateral in case of default. In many cases, the lender will cap your credit limit at 85% of the appraised value of your home, minus what you owe on your first mortgage.
  • Business line of credit: Some lenders will also offer secured lines of credit for business owners if you pledge collateral, which may give you a better interest rate. But be aware that some may charge an annual fee or origination fee and have other requirements, like the age of your business.

Alternatives to a secured line of credit

If you don’t think a secured line of credit is right for you, there are other options out there for you to consider.

  • Unsecured lines of credit: While you might pay a higher interest rate with an unsecured line of credit, you won’t be putting your property on the line to secure the loan. If you’re concerned about losing an asset, this may be a better option for you.
  • Home equity loan: If a HELOC doesn’t sound appealing, you could take out a home equity loan, which also lets you borrow money against your home’s equity. The main difference is that you’ll receive your loan amount in one lump sum that you must pay back in installments with interest.
  • Credit card cash advance: If you want a short-term loan, you can borrow against the available balance on your credit card with a cash advance. Just be aware that your credit card company will likely charge you a higher interest rate than for your normal purchases, as well as a processing fee.
  • Credit card balance transfer: If you’re thinking about consolidating debt with a secured line of credit, you may opt for a credit card balance transfer with a lower interest rate instead. Just remember that your debt won’t be eliminated — you’re just simplifying your payments, and hopefully saving money by getting a lower interest rate than the average interest rate of your combined debts.

Bottom line

A secured line of credit may be a good idea if you have an asset like a home or car that you’re willing to pledge and are confident you’ll be able to pay back your loan.

Before you take out any line of credit, make sure the monthly payments will fit into your budget so you don’t get in a financial jam.

About the author: Anna Baluch is a freelance personal finance writer from Cleveland, Ohio. You can find her work on sites like The Balance, Freedom Debt Relief, LendingTree and RateGenius. Anna has an MBA in marketing from Roosevelt Un… Read more.