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What is an Unsecured Line of Credit and How Does It Work?

TLDR

What You Need To Know

  • Unsecured lines of credit let you borrow funds up to your credit limit without providing an asset, like your car or house, for the lender to seize if you default on your payments
  • Unsecured lines of credit have minimum monthly payments you’ll need to meet. Beyond that, you’re permitted to revolve, or carry a balance, from month to month
  • Unlike a loan like a mortgage designated for a specific purpose, you can withdraw unsecured lines of credit and use the funds to pay for anything

Contents

Are you considering a kitchen repair, starting up that small business you’ve been dreaming about or trying to figure out how you’ll scrape by in the summer months with your seasonal job?

An unsecured line of credit may be just the thing. A line of credit is a type of revolving credit, meaning you can withdraw, repay and withdraw again. Your credit limit is restored as you pay it back. You’ll generally get a checkbook or a debit card to use to withdraw funds and make payments with your line of credit.

Think of it like a tank of gas in your car. You can only go as far as the tank will go, but as long as you refill your tank, you can keep driving. You don’t need to apply for a new loan every time.

An unsecured line of credit operates like a credit card, since it lets you borrow up to your credit limit without putting up any form of collateral.

Lines of credit fall into two categories: secured loans and unsecured loans. We’ll be focusing on unsecured lines of credit in this article. Let’s hit the road!

Understanding Unsecured Lines of Credit

What makes a line of credit unsecured?

Unsecured lines of credit let you borrow funds up to your credit limit without providing an asset, like your car or house, for the lender to seize if you default on your payments. Meanwhile, secured lines of credit are backed by collateral, like any secured loan (think home equity loan).

Unsecured lines of credit have minimum monthly payments you’ll need to meet. Beyond that, you’re permitted to revolve, or carry a balance, from month to month. The interest is only charged on the debt you revolve.

Types of unsecured lines of credit

There are two primary types of unsecured lines of credit: a business line of credit and a personal line of credit. You can get either through a bank, credit union or online lender.

  • Unsecured business line of credit: A type of small business credit line for you to withdraw funds for business expenses. A business line of credit is designed to help cover start-up costs, materials or equipment you’ll need for success.
  • Unsecured personal line of credit: A type of personal credit line that gives you financial flexibility, since you can borrow against it to pay for many different things.

Pros and Cons of Unsecured Line of Credit

Because you’d be taking on new debt, it’s important to manage it well, make payments on time and still spend within your means. Remember, you’ll eventually have to pay back everything you spend.

There are a few advantages and disadvantages to unsecured lines of credit you’ll want to consider before you take one.

An unsecured line of credit is a great way to finance big payments coming your way. But they can be more expensive in the long run if you don’t manage them wisely.

PROS of unsecured lines of credit👍

No collateral required

If you fail to make payments there’s no physical property the lender can seize, but they can send a collections agency after you to collect the debt.

Funds can be used for anything

Unlike a loan like a mortgage that’s designated for a specific purpose, unsecured lines of credit can be withdrawn and used to pay for anything. This means you could use the same line of credit for medical bills and a renovation, rather than needing to take out two separate loans.

Quick processing time

A secured line of credit, like a home equity loan, can take weeks to process and approve because of the collateral and the extra paperwork that entails. An unsecured line of credit can get approved quickly, usually in a matter of days.

CONS of unsecured lines of credit👎

Higher interest rate

Because unsecured lines of credit lack collateral, the interest rates tend to be higher.

Smaller loan amount

For the same reason interest rates run higher, your credit limit will be smaller since no collateral is used to secure your debt.

Risk of overspending

Like a credit card, there’s always a risk of spending beyond your means. While lines of credit are designed to help you pay for things you can’t afford at the moment, you need to at least be able to afford them long term. Make sure you’re realistic about how much you withdraw and be sensible with your spending.

Need a good credit score

You’ll need at least a good credit score to qualify for an unsecured line of credit. Your interest rate and credit limit will depend on your credit history.

When An Unsecured Line of Credit Makes Sense

You can use an unsecured line of credit a handful of ways. It all depends on what you need and your ability to pay it back. Many people take out lines of credit for home renovations, medical bills or education costs. Let’s explore a few options.

  • Home renovations: If you’re finally redoing that 1980s kitchen, building a new garage or some other major renovation, a line of credit can help you with construction costs.
  • Ongoing expenses: If you have ongoing expenses, such as paying tuition or covering the cost of medical bills, you can use a credit line to pay those bills.
  • Outstanding debts: If you’re looking to consolidate credit card debt, interest rates for an unsecured line of credit will probably be lower than paying debts off with a credit card.
  • Inconsistent income: If you have a seasonal job or otherwise inconsistent income, a line of credit can help you pay bills and make necessary purchases during the down times.

Don’t Be Insecure About an Unsecured Line of Credit

Whether you’re looking for an unsecured business line of credit or an unsecured personal line of credit, you’ll want to consider the monthly payment amount, how you’ll use it and the interest rate. An unsecured line of credit can be as useful as a full tank of gas during a high-speed car chase, but you’ll need to manage it well.

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  1. Experian™. “What Is a Good Credit Score?” Retrieved April 2022 from https://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-is-a-good-credit-score/

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In Case You Missed It

  1. A line of credit is a type of revolving credit, meaning you can withdraw, repay and withdraw again

  2. You’ll generally get a checkbook or a debit card to use to withdraw funds and make payments with your line of credit

  3. There are two primary types of unsecured lines of credit: a business line of credit and a personal line of credit. You can get either through a bank, credit union or online lender

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