Contributing Writer at Tally
March 25, 2021
A line of credit gives you access to flexible funds to consolidate debt, complete a home improvement project, and more. You can use as much or as little of the line of credit as you need and will only pay interest on the amount you use.
Speaking of interest, lines of credit typically have a variable interest rate based on the prime rate, which is the interest rate banks charge their most creditworthy corporate customers. If the prime rate goes up, your variable rate will likely rise too, increasing the cost of borrowing from your line of credit.
There are two main types of lines of credit: secured and unsecured.
You may wonder what a secured line of credit is and how it differs from an unsecured line of credit. We'll cover that and more.
Secured lines of credit give you access to flexible cash you can borrow as you need. And, you’ll only pay interest on the amount you use. Like a credit card, your secured line of credit will have a credit limit, which is the most you can borrow at one time.
Most lines of credit will have two phases: a draw phase and a repayment phase. During the draw phase, you can take loans from the line of credit and make interest-only monthly payments.
You can no longer take out loans in the repayment phase. During the repayment phase, you’ll make principal and interest payments for a fixed period until you pay off what you borrowed.
The term "secured" means there is an asset securing the loan, also known as collateral. The collateral gives the lender something of value — like a home or a business asset — to seize if you fail to repay the line of credit.
There are two common types of secured lines of credit that cater to different borrower types: personal lines of credit and business lines of credit.
Personal lines of credit allow individuals to access cash for their personal expenses.
For example, a home equity line of credit (HELOC) is a common personal line of credit that a homeowner can use for home improvements, debt consolidation, and more. A HELOC gives you access to cash based on your home's equity — the value of your home minus any mortgages or loans on the home.
A HELOC uses your home as collateral, so if you default on the payment, the lender can foreclose.
Most lenders limit their HELOC amounts to a predetermined percentage of the home's appraised value. This is known as the loan to value. For example, Discover's HELOC program allows a total loan to value up to 90% of the home's value.
This total loan to value is the total appraised value of the house divided by all mortgages on the home and the HELOC amount.
So, if you have a $400,000 mortgage on a home worth $500,000, you could get up to a $50,000 HELOC because the $400,000 mortgage plus the $50,000 HELOC would equal $450,000, which would be 90% of the home's $500,000 value.
Businesses also sometimes need flexible cash to improve their facilities, cover overhead costs, handle unexpected expenses, purchase additional real estate, and more. Businesses can use lines of credit to help cover these expenses.
Businesses can also use these lines of credit for extra cash flow or working capital during slow periods without paying interest on funds they don't spend.
Like a HELOC, a business line of credit generally requires collateral. Business owners can put up the business' building, equipment, vehicles, accounts receivable, or other assets with significant value as collateral.
Here are some other lending options you may want to consider instead of a secured line of credit.
An unsecured line of credit, like what Tally offers to help people pay off debt, is similar to a secured line of credit, but it doesn’t require collateral. Because the lender has limited recourse if you default on an unsecured line of credit, it's taking on a significantly higher risk, which may lead to a higher interest rate.
Even with a slightly higher interest rate than a secured line of credit, you’ll can still save compared to carrying credit card debt.
A home equity loan is similar to a HELOC, as it allows you to borrow against the equity in your home and uses your home as collateral. The key difference is a HELOC allows you to make multiple draws from the line of credit within a set time frame, whereas a home equity loan is a lump-sum secured loan.
Another difference is a HELOC allows you to make interest-only payments for a certain period. In contrast, a home equity loan requires fixed monthly installment payments during the entire loan term.
A personal loan, like a home equity loan, is a lump-sum loan with fixed monthly installments. It requires no collateral and is generally an unsecured loan. Because there's no collateral, a personal loan may also have a higher interest rate.
Credit card cash advances are another option for folks who need quick cash. To get a cash advance, you can go to an ATM and use your credit card to take out cash, just like you would with a debit card.
Your credit card issuer should have sent you an ATM PIN when you first got the card. If you no longer have this PIN, you can call the customer service number on the back of your credit card to reset it.
Cash advances are more convenient than a secured line of credit because they're quick, there's no application period, and the interest rate is typically fixed. However, they come with extra fees, including:
Higher interest: Cash advances generally follow a different interest rate scheme than credit card purchases. This rate is usually a few percentage points higher.
Upfront fee: Cash advances also usually come with an extra 3% to 5% fee. So, if you took $100 from the ATM, you'd pay an extra $3 to $5.
ATM fees: ATMs charge fees for using cards from other banks, so unless you find a fee-free ATM or one related to your credit card, you'll have to pay this fee.
It may sound horrible to put up collateral for a line of credit, but there are some distinct advantages to getting a secured line of credit.
Because the lender is mitigating its risk by having an asset as collateral, the lender may offer you a lower interest rate on a secured line of credit. This isn't always the case, but it's a possibility.
If you have fair or bad credit, you may struggle to get approved for an unsecured line of credit. However, with the reduced risk collateral brings to the table, lenders may be more willing to approve your less-than-perfect credit score.
Bad credit isn't the only thing that can keep you from getting approved. A lender may also deny you because your debt-to-income ratio is too high or you had a recent career change. However, with strong collateral, a lender may be willing to approve you on a secured line of credit.
With an asset securing your loan and reducing a lender’s risk, this may open the door to more lenders to choose from. With more lenders comes the ability to shop for the best rates possible.
A secured line of credit's pros are strong, but there is also an assortment of cons to keep in mind when considering one.
The biggest con of a secured line of credit is the risk of losing the asset you put up as collateral. If you run into hard times and can't repay the line of credit, the lender can seize the property with relative ease.
Because the lender uses the collateral to offset some or all of the risk, they often tie the loan amount directly to the collateral's value. For example, if you put your home up as collateral, the lender may limit your line of credit to 80% of the home's value.
Common issues with all lines of credit are the fees. Some secured lines of credit include an array of origination and monthly or annual maintenance fees. Traditional loans often have origination and other fees when the bank funds the loan, but they usually have no ongoing fees other than interest.
Secured lines of credit can be a great option in very specific circumstances, particularly when you have a home or business with equity in it. They offer you accessible cash that you can draw on as you need, and the best part is you pay interest only on the cash you use, not the line of credit itself.
There are, however, some things to consider, including:
The various other loan options and how they fit your needs
The potential of losing the asset your securing the line of credit with
The additional fees that may come with a secured line of credit
Taking these variables into consideration can help you decide if a secured line of credit is right for you. If not, there are plenty of other options to consider, including home equity loans, personal loans, credit card cash advances, unsecured lines of credit, or a Tally line of credit.
Disclosure: To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.9% - 25.9% per year. The APR will vary with the market based on the Prime Rate. This information is accurate as of March 2021.