Secured vs Unsecured lines of credit: What's the difference?

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Believe it or not, 32% of all payments in the United States are made on credit— according to the Survey and Diary of Consumer Payment Choice— showing that credit plays a huge role in the financial plans of people across the country. Because of the impact credit has on finances, it may be important to understand how best to leverage credit usage to your advantage. 

With that said, there are several different credit types to choose from, and learning about each one can be the first step to getting the most out of your individual credit situation. One way credit lines are classified are as secured and unsecured. But what’s the difference between the two, and which could be a better fit for you? Today, we unpack these questions.

Read more: The pros and cons of lines of credit

What is a Secured Line of Credit?

A secured line of credit is a flexible borrowing tool that lets you access funds up to a predetermined limit. In order to access this type of credit, you offer something valuable as security. This can be your car’s title, money in a savings account, or in the case of a HELOC (Home Equity Line of Credit), your personal real estate. By putting up collateral, you may qualify for lower interest rates compared to other borrowing types that do not require collateral. As you pay back what you owe, you may be able to borrow again up to your borrowing limit, making it a handy option for managing finances. However, keep in mind that the lender has the right to seize the asset if the borrowed funds are not paid back per the terms of the agreement.

Some common types of secured lines of credit include:

• Home Equity Lines of Credit (HELOCs): With a HELOC, you typically use the equity you've built up in your home as collateral.

• Car title loans: A car title loan uses your vehicle as collateral. The lender will typically assess your car's value and may offer you a line of credit based on a percentage of that value.

• Secured Credit Cards: These credit cards are backed by a cash deposit. This usually becomes your credit limit. Secured credit cards are typically used to build or rebuild credit. One example would be the Varo Believe Credit-Builder Card¹.

When you take out a secured line of credit, collateral acts as financial reassurance for the lender. By putting up an asset, you're showing you have something of value that the lender can claim if you don't hold up your end of the bargain. This, in turn,  can reduce the lender’s risk, which is why they may be willing to offer you lower interest rates or a higher credit limit, even if you don’t have an established credit history.

According to a 2022 TransUnion report, more than 45 million Americans lack the credit history to qualify for many unsecured credit lines, making secured options a common approach to managing finances, regardless of how risky they can be.

What is an Unsecured Line of Credit?

An unsecured line of credit is a type of flexible credit that doesn't require collateral approval. Instead, it only looks at how trustworthy you are with repaying financial obligations. This credit type lets you access funds right away without the risk of losing assets if you can't repay. It's commonly used by both individuals and businesses. Credit cards are a popular example of this type of credit, but they often have higher interest rates to make up for the extra risk posed to the lender. 

Some common types of unsecured lines of credit include:

• Personal Lines of Credit: An unsecured personal line of credit or unsecured personal loan can be used for many purposes, such as covering unexpected expenses or financing large purchases. 

• Unsecured Credit Cards: Some credit cards may be considered a form of unsecured credit lines. When you use your credit card, you're borrowing money from the card issuer, which you'll need to pay back with interest if you don't pay your balance in full each month.

• Student loans: A student loan allows students to borrow money to pay tuition and other school expenses without providing collateral. This money is then paid back after the student leaves school.

• Auto loans: Auto loans are typically unsecured lines of credit. They enable individuals to purchase a vehicle, with the loan amount repaid over a specified period with interest.

How do lenders limit risk with unsecured lines of credit?

Since there's no collateral involved, lenders may rely heavily on your credit score and credit history when deciding whether to approve you for an unsecured line of credit. They want to see that you have an established track record of responsible borrowing and repaying your debts on time. 

As a result, sometimes unsecured lines of credit can be more difficult to qualify for than secured lines of credit, especially if you have a limited or less-than-perfect credit history. However, if you do qualify for an unsecured credit line, it could provide a more flexible way to borrow money when needed, without putting your assets in jeopardy as collateral.

Even though there's no collateral at stake when using an unsecured line of credit, it's still important to borrow responsibly and make payments on time to avoid potential damage to your credit.

Read more: How to get a line of credit with bad credit

A Detailed Comparison of Secured vs Unsecured Lines of Credit

Now that you have a basic understanding of secured and unsecured lines of credit, let's do a deep dive into their primary differences. By comparing key factors like interest rates, credit requirements, approval processes, loan amounts, and repayment terms, you'll be better equipped to choose the option that best suits your individual financial situation.

Secured Lines of Credit

Interest Rates

Interest rates for secured lines of credit are typically lower compared to unsecured credit lines. By backing your credit line with collateral, such as a home or car, the lender’s risk is reduced, often allowing them to offer better interest rates.

The interest rate for a secured line of credit is typically variable and tied to a benchmark like the prime rate (ie. the interest rate banks charge their most creditworthy customers). These variable interest rates may fluctuate over time based on market conditions.

Credit Requirements

When applying for a secured line of credit, lenders can usually be more focused on the value and quality of the collateral provided rather than solely relying on the borrower's credit health. This means that individuals with lower credit scores (or a less robust credit history) may still qualify for a secured line of credit if the collateral is deemed acceptable and valuable enough to secure the loan.

Approval Process

The approval process for secured lines of credit is often faster and less stringent compared to unsecured lines of credit. Since the collateral reduces the lender's risk significantly, the underwriting process may be expedited, leading to quicker approvals. Although, it’s important to note that some collateral evaluations may take longer than others.

Loan Amounts and Limits

Secured credit lines allow borrowers to access larger amounts of cash by providing valuable assets as collateral, thus reducing the lender's risk. The loan amount is based on the value of that collateral, so higher valued assets generally translate to higher borrowing limits. As the value of the collateral appreciates, borrowers might have the opportunity to increase their borrowing limit over time, providing an avenue to higher funding amounts in the future.

Repayment Conditions

Secured lines of credit may have more lenient repayment conditions due to the lender’s reduced risk. With collateral backing the credit, borrowers typically benefit from longer repayment periods and lower interest rates. This setup allows for more flexibility in managing repayments, making it feasible to spread the loan over an extended period and easing the financial burden on the borrower. However, these longer repayment periods could still lead to a higher cost over the life of the loan, even with lower interest rates.

Advantages of Secured Lines of Credit

• Higher Loan Amounts: Secured lines of credit often offer access to larger sums due to the collateral involved, generally making them suitable for significant expenses or investments.

• Lower Interest Rates: Since these lines are backed by collateral, lenders often view them as less risky, which could result in lower interest rates compared to unsecured options.

• Increased Approval Odds: Due to the reduced risk that collateral provides to lenders, individuals with lower credit scores or a limited credit history may find it easier to get approved for a secured line of credit relative to unsecured options.

• Flexible Repayment Terms: Because lenders have less risk with secured credit lines, borrowers typically benefit from more flexible repayment schedules and terms. This could make it easier to manage payments over a longer period.

• Opportunity for Credit Building: Timely repayments on a secured line of credit can positively impact your credit history over time and contribute to a stronger credit profile.

Disadvantages of Secured Lines of Credit

• Risk to Collateral: Defaulting on payments can lead to the loss of the collateral, such as a home or vehicle, putting the borrower's assets at risk.

• Limited Access Without Collateral: Individuals who lack valuable assets to pledge as collateral may face challenges in accessing secured lines of credit with generally more favorable terms.

• Interest Costs Over Time: While interest rates may be lower initially, the total interest paid over the life of the loan can add up, especially if the repayment period is extended.

• Potential Impact on Credit: Defaulting on a secured line of credit can severely damage one's credit score and financial stability, making it crucial to prioritize timely repayments.

Unsecured Lines of Credit

Interest Rates

Unsecured lines of credit typically have higher interest rates since the lender takes on more risk without collateral in the case of default. These interest rates can be either fixed or variable, depending on the lender and specific terms of your credit agreement. 

Note: Interest rates are currently higher than previous years. In fact, the Federal Reserve reports that the average interest rate for credit cards in 2024 is 21.59%— although the better your credit, the better rate term you could receive. These heightened interest rates could make atypical credit lines with one-time flat fees, like Varo Line of Credit², much more appealing for individuals with a sparse credit history. 

Credit Requirements

Unsecured lines of credit typically rely on the borrower's credit history, credit score, and overall financial health since there is no collateral to secure the loan. Lenders evaluate the borrower's creditworthiness to assess the risk of default. Individuals with poor credit scores, a limited credit history, or a high debt-to-income ratio may find it challenging to qualify for an unsecured line of credit due to the risk involved for the lender.

Approval Process

Approval processes for unsecured lines of credit are usually more thorough and detailed compared to secured lines of credit. Lenders generally review the borrower's financial information, employment status, income stability, credit report, and debt obligations to assess the risk associated with lending money without collateral. The evaluation process may involve credit checks, income verification, and a comprehensive review of the borrower's financial stability. Due to the higher risk for the lender, approvals for unsecured lines of credit typically take longer and require more documentation to ensure the borrower's ability to repay the loan.

Loan Amounts and Limits

Unsecured credit lines usually provide smaller loan amounts based on creditworthiness and financial stability, making them preferable for minor expenses, emergency situations, or short-term financial needs. Credit limits are often established by considering factors like credit history, income stability, and existing debts, often leading to lower borrowing limits than secured lines of credit. However, a strong credit profile can still help you qualify for higher amounts than those with little or no credit.

Repayment Conditions

Unsecured lines of credit generally come with stricter repayment terms than secured credit lines. Lacking collateral, these lines usually feature shorter repayment periods and higher interest rates to offset the increased risk for lenders. Borrowers might encounter more rigid repayment schedules and potentially steeper penalties for late payments with unsecured credit lines. This means that prompt and disciplined repayment may be necessary to avoid interest charges or other consequences of payment delays.

Note: Varo Line of Credit² takes a different approach to unsecured lines of credit. While you still have a set number of months to repay, Varo does not charge late fees or recurring interest like most traditional unsecured credit lines do. Instead, the benefit of making on-time payments is the potential for higher borrowing limits and having payments reported to credit bureaus, which may help your credit profile improve over time.

Advantages of Unsecured Lines of Credit

• No Collateral Required: Unsecured lines of credit typically do not necessitate collateral, offering borrowers access to funds without risking their assets.

• Quick Approval Process: Compared to secured options, unsecured lines of credit typically involve a faster approval process, often making them suitable for urgent financial needs.

• Flexible Use of Funds: Borrowers can use funds from unsecured lines of credit for various purposes, ranging from everyday expenses to unexpected emergencies.

• Build Credit History: Responsible management of an unsecured line of credit can help individuals establish and improve their credit history over time.

• Convenience and Accessibility: Unsecured lines of credit provide a convenient source of funds that can be accessed quickly and easily, offering financial flexibility.

Disadvantages of Unsecured Lines of Credit

• Higher Interest Rates: Unsecured lines of credit often come with higher interest rates compared to secured options due to the increased risk for lenders.

• Limited Borrowing Limits: Without collateral, the borrowing limits for unsecured lines of credit may often be lower, which could restrict access to higher balances.

• Stricter Eligibility Criteria: Lenders may require a stronger credit history and financial profile for approval of unsecured credit lines, potentially excluding individuals with poor or limited credit history.

• Risks of Defaulting: Failing to make timely payments on an unsecured line of credit could lead to negative consequences such as damage to your credit history, accumulation of debt, and potential legal actions if you would default on the payment arrangement defined in the terms.

Which Line of Credit Type is Better for You?

Now that we’ve done a deep dive into secured vs unsecured lines of credit, how do you choose what’s right for your financial situation? Ultimately, you need to weigh the pros and cons of each option (see advantages/disadvantages above) then consider factors like your individual financial goals, risk tolerance, and available assets. However, here are some circumstances that might lend themselves to one choice over the other.

When to Choose a Secured Line of Credit

There may be several situations that might justify a secured line of credit. If you need a particularly large amount of money for long-term financial goals like a home renovation or to start a business, a secured line of credit may give you access to higher loan amounts at the risk of losing your assets upon defaulting. In addition, if you don't have a long credit history or if your credit is less than ideal, a secured line of credit might be easier to access because the collateral reduces the lender’s risk. Review the complete list of pros and cons for secured credit lines above.

When to Choose an Unsecured Line of Credit

If you don't have valuable assets to use as collateral, or if you don’t want to risk the assets you do have, then an unsecured line of credit might be the better choice. While these unsecured credit lines typically have lower borrowing limits, they are often better suited for urgent financial needs due to their more streamlined approval process— although qualification requirements could be stricter compared to many secured options. Review the complete list of pros and cons for unsecured credit lines above. 

In addition, some borrowers may prefer an unsecured line of credit that allows them to pay a single flat fee instead of accruing interest. While this option is less common, it can be found in select products, such as Varo Line of Credit².

A Line of Credit for the Everyday Person

Choosing between a secured and unsecured line of credit is a significant financial decision that requires careful consideration of your individual needs, goals, and circumstances. With that said, many Americans find that secured credit lines can be too risky for their situation, especially if they don’t need more than a couple thousand dollars— that’s where Varo Bank can help.

We’ve designed something different, Varo Line of Credit, an unsecured personal line of credit that allows you to borrow between $600 and $2,000 without recurring interest. That’s right, once approved, you can take out money for a transparent one-time fee and avoid the late fees and prepayment penalties that come along with traditional lines of credit. 

The more you bank with Varo and make on-time payments, the more qualified you could be to increase your borrowing limit over time, allowing you to be better prepared for unforeseen expenses or short-term cash flow problems.

Get started with Varo today or click to learn more about Varo Line of Credit!

^{1 The Varo Believe Secured Credit Card is designed to help you build your credit; however, a variety of factors impact your credit and not all factors are equally weighted. Building credit may take time and Varo Believe may be able to help when you consistently make on-time payments.}

^{2 The Varo Line of Credit is designed to help customers with unforeseen expenses with monthly payments, no late fee, no prepayment penalties, and no interest. To be eligible, your accounts must maintain a positive balance. Minimum monthly deposits, average daily balances, and other eligibility requirements apply. Once qualified for Varo Line of Credit, you will be assigned a credit limit from $600 to $2,000. A one-time fee is added to your borrowed amount, early repayment of your advance does not reduce the one-time fee. Your credit limit may fluctuate from one advance to the next based upon a variety of factors. You may only take one Varo Line of Credit out at a time. Your eligibility information and/or credit limit is always available to you in the home screen of your Varo app. Checking offer eligibility will not impact your credit score. If you are eligible and choose to apply for an offer, we will pull your credit and your credit score may be impacted.}