What is the Definition of a Secured Line of Credit?
A secured line of credit can be a great way for a business owner to grow his or her business operations. A line of credit offers an entrepreneur with a set amount of credit. He or she may withdraw as much money as needed up to the credit limit, only paying interest on the amount borrowed.
A secured line of credit, as with any “secured” loan, is connected to an asset or property. When a small business owner secures a line of credit, he or she offers equipment, real estate, or other valuable goods as collateral. If the business owner does not make their monthly payment on time or in full, then the financial institution that provided the credit line can seize the collateral as a form of payment. For instance, a common secured line of credit is a house or other kind of real estate mortgage. If the borrower defaults on the mortgage, then the lender will be able to confiscate the property.
While a secured line of credit has a number of advantages, there are also some significant disadvantages to consider.
What Are the Pros of a Secured Line of Credit?
Secured Lines of Credit Typically Have Low Interest Rates
One of the biggest advantages of secured loans is the fact that they usually have low interest rates. Lenders assess their risk when deciding on interest rates. The higher they consider the risk, the higher they set the interest rate.
A secured line of credit is backed by an asset, which means that the lender is accepting less risk. If the business owner defaults on the line of credit, then the lender will sell the seized asset to make up for their losses. Because of lower risks, a lender can afford to offer more favorable interest rates.
Lower Credit Scores Are Okay
Business owners who suffer from a poor credit history are more likely to have trouble applying for financing. Thankfully, secured lines of credit have lower risks, so lenders will generally be less worried about credit score. Mainly, lenders care about credit history because it tells them how likely a borrower is to repay their loan.
A secured loan means that a borrower’s collateral lowers their risk and increases the probability that he or she will make their payments on time and in full. Because a business owner does not want to forfeit the assets that they tied to the secured line of credit, they will do their best to repay the loan.
That said, a business owner’s credit score does have some impact on the terms of the loan. A lender will think of lower credit scores as more of a risk, which means that the borrower will have to pay higher interest rates. In any case, interest rates for secured line of credit will typically be lower than unsecured lines of credit. A business owner might even be approved if he or she has a poor credit history.
Might Receive Longer Loan Repayment Terms
Lower risk does not only reduce interest rates. Lenders might provide longer loan repayment terms. This is due to the collateral that a business owner can offer to secure a line of credit.
Sometimes, a lender will provide repayment periods of up to ten years. Since borrowers often use business property to back secured loans, lenders can benefit from rising property process to increase the value of the collateral over time.
What Are the Cons of a Secured Line of Credit?
Valuable Collateral Necessary
The benefits of a secured line of credit derive from the loan being secured by collateral. However, this also means that a business owner will need to offer an item of value to secure the line of credit. Typically, this means a borrower will have to offer a home or other piece of valuable property. This might also mean equipment, invoices, or inventory. If a business owner does not have any valuable assets such as these, then he or she will have a hard time getting a line of credit.
Could Lose Assets
If a business owner defaults on his or her business loan, then they will probably lose the asset that is connected to the loan. Because a business owner agreed to the terms of the loan and offered the asset as collateral, there will be almost no legal recourse, if any at all.
It is important to remember that a business owner must be careful when using collateral to secure a line of credit. The lender takes on less risk, but the risk increases greatly for the borrower. It is best, if possible, to use collateral that is not necessary to one’s business operations. This way, if the asset is seized, the business can still function as normal.
For instance, it may be a better idea to secure a loan with business property than one’s personal home. If a business owner must close their business, they will not need the property, but they will certainly need their home.
Be Careful of Variable Interest Rates
Secured lines of credit offer low interest rates, but these are usually variable. If interest rates go up, then they can become troublesome to the business owner.
It is important to ensure that a business owner understands the specific terms of the secured line of credit prior to signing anything. While it is a good idea to have access to business funding, it is not ideal to be saddled with high interest rates.
There are many benefits to secured lines of credit, but there are also some negatives. In the end, a secured line of credit is a great option if a business owner would like access to money that can be withdrawn as needed. However, a business owner should be careful to only take as much as they need so that the company’s finances are protected.
It is important to remember that a borrower will have to put up valuable assets to secure the credit, which can increase a business owner’s risk. They might even lose their home or other valuable assets if things go wrong. A business owner should weigh these pros and cons before making any funding decisions.