Revolving lines of credit are lending tools different from traditional loans. With a line of credit, a maximum amount of credit extended to the borrower; but, the borrower may choose to use only a portion of the available funds. Monthly payments are based on the amount outstanding, interest is only charged on the funds actually borrowed, and any principal repaid becomes available as credit again. Additionally, unlike traditional loans, there is no requirement that the money is used for a designated purpose.
A line of credit can be secured or unsecured and there are important differences between the two. Most significant, secured lines of credit require collateral for the debt whereas unsecured credit lines do not require anything pledged as security.
Secured lines of credit
With a secured line of credit, some form of collateral is required as security for the repayment of the loan. Security usually takes the form of tangible assets such as equipment, vehicles, or even securities. The lender will establish a lien against the assets pledged as collateral and if the borrower defaults, the assets can be seized and liquidated by the lender to repay the debt.
Secured lines of credit are more attractive to lenders than unsecured ones by virtue of the collateral. If the borrower defaults, the lender has a way of recouping all – or at least some – of the outstanding debt. Because secured credit lines are safer for the lender than unsecured lines, qualification may be easier, interest rates tend to be more attractive, credit limits tend to be higher, and payback timelines may be longer.
Unsecured lines of credit
With an unsecured line of credit, there is no collateral. Thus, if the borrower defaults, there are no assets that can be easily repossessed to pay outstanding debt. Because of the increased risk, qualifying for unsecured credit lines is tougher and interest rates will be higher. Additionally, maximum extended credit will likely be lower and the payback period will typically be shorter.
It is important to note, while specific assets may not be pledged as security for an unsecured credit line, creditors may be able to establish a general lien against all assets. That means, in a default, lenders may seek a judgment against any company assets for repayment.
Whether secured or unsecured, revolving lines of credit are an important tool in business borrowing. Contact Bear River Financial to help you select a credit line that is right for your company’s needs.