Does a line of credit require collateral?

Whether you're looking to cover unexpected expenses or making a large purchase in the near future, understanding when or why collateral may be needed to secure your loan can help you make a smarter and more aligned financial decision.

To learn more about whether or not you need to tie your assets to your line of credit, stay tuned for the full scoop.

What is a line of credit?

A line of credit is a type of loan offered by credit unions and financial institutions alike. However, rather than obtaining a lump sum payment once your application is approved, borrowers can access funds on an ongoing basis when they need, up to your credit limit. As you continue to borrow money from your line of credit, you'll only pay interest on what you borrowed.

Most lines of credit have a variable interest rate, which means the interest you pay when you borrow money each month can fluctuate based on Canada's prime rate.

What is a secured line of credit?

When applying for your line of credit, you'll likely be given the option of a secured or unsecured line. So, what exactly does having a secured line mean when it comes to personal loans? A secured line of credit is a type of bank loan that requires collateral from the borrower in order to be approved.

Collateral can be any type of high-value asset, including your home, car, and other valuables. Essentially, it acts as a guarantee to a financial institution that if you fail to repay your loan, they can seize your assets and recover the funds.

What is an unsecured line of credit?

On the other hand, an unsecured credit line does not require collateral when borrowing money. A financial institution, instead, will take a look at your credit history, your employment salary, and general financial history to determine whether you are eligible for a credit loan and what your available credit limit will be.

Secured vs unsecured line of credit, which is better?

So, secured vs unsecured line of credit, which one is better? In truth, both have pros and cons, and the one you choose will come down to your plans for spending and saving. Here's a closer look at both so you can get a better idea about what to expect:

Secured line pros

• Secured lines typically have lower interest rates than unsecured lines.

• You can also be approved for a higher credit limit.

• Secured lines also offer potential tax advantages, depending on the type of collateral you offer.

Secured line cons

• You do run the risk of losing your assets should you experience financial trouble and are unable to make your monthly payments.

• To be approved for a secured line of credit, your financial institution will typically put you through a more extensive application process that takes longer to complete.

Unsecured line pros

• There is no collateral required for an unsecured line, which means you will not have to forfeit your assets if you are unable to make payments.

• The application process for unsecured lines is quicker and easier for those applying.

• These lines of credit are suitable for individuals who do not have that many assets to begin with as long as they have a good credit score.

Unsecured line cons

• These lines of credit often have higher interest rates and a lower credit limit.

• If your credit fails a credit check, you may have a harder time being approved.

Aren't sure what your current credit scores are? Get a free credit score check and build your credit with KOHO!

Types of credit lines available

When applying for a line of credit, you'll have the option of choosing between the following:

Personal line of credit

A personal line of credit is similar to having your own credit card. Unlike credit cards, they typically have a lower interest rate. However, because it's a personal line of credit, the lending institution will conduct a credit report, which will influence the interest rate you're offered. And as you probably guessed, having a higher credit score in this scenario can help you secure a lower rate.

Once your application has been approved, you'll be able to withdraw money from an ATM, write a cheque, and transfer money from your credit line into your chequing account. With personal lines, you can use the money for auto loans, debt consolidation, emergency expenses, and more, depending on your financial needs.

Unlike other types of credit lines, personal lines do not require collateral.

Student line of credit

A student line of credit is specifically designed to meet the unique needs of Canadian students attending a post-secondary educational institution. A student line of credit works similarly to a personal line, as you'll be able to withdraw money during your time in school. You can also use the borrowed money to pay for things like tuition, textbooks, meals, housing, and other school-related costs.

With this line of credit, you'll have flexible repayment terms where only a minimum payment is needed each billing period. Students will also get a grace period of 12 months following their graduation date to begin paying back their principal loan with interest.

Again, you do not need to offer your bank or credit union collateral in order to be approved for a student line or credit.

Home equity line of credit

A home equity line, also known as a HELOC line of credit, is a type of loan you can get from a financial institution with the equity you already have in your home. With home equity lines of credit, you can borrow money against your property by allowing you access to money that has already been repaid to your mortgage. Essentially, equity is determined by your home's current market value minus your outstanding mortgage balance.

Like student lines and personal lines, HELOCs will have variable interest rates that can rise and fall with the prime rate established by the Bank of Canada. Further, using a home equity line, you can pay for home renovations, consolidate your debt, and make other large purchases. Just keep in mind that there are home equity line of credit pros and cons that you should weigh before opting for this method of lending compared to a more traditional loan.

And, as you can probably guess, because you are using the equity that's already tied into your home, this line of credit does require collateral upon approval.

Business line of credit

Lastly, a business line of credit is available to help entrepreneurs kick-start their business ventures. The credit limit offered by a financial institution will be based on the credit history of the business owner(s), which is why having a strong credit score is a must.

With a business credit line, you can use the funds for your business's cash flow, purchase inventory for your store, and pay for other related expenses with ease. Because these types of credit lines are unsecured, they also do not require the borrower to have collateral.

How is interest calculated for a credit line?

You may be wondering, "How is interest calculated on a line of credit?" Although the lender's technique varies somewhat, most determine your interest by dividing the annual rate of interest by 365 to obtain a rate per day. Your financial institution will then apply the daily rate to the sum of money borrowed. The daily interest costs will then be added up at the end of the month when you receive the billing statement.

However, if you have a student line of credit, for example, you will only need to make the minimum monthly payment while you are in school before paying the principal loan following your graduation.

What are the requirements for a line of credit?

When applying for any line of credit, your financial institution will consider several factors before determining whether you qualify and how much of a loan you qualify for. While the parameters may change between lenders, here are some of the factors you'll be evaluated on:

• Your current employment income.

• Whether you have any debt and the amount of debt you have.

• Your current credit score and what your credit history looks like.

What is the difference between a personal loan and a line of credit?

Now that you have a better idea about what a line of credit is and which ones require collateral upon approval, you may be wondering if you should get a personal loan vs line of credit. Let's break it down for you:

Personal loan

With a loan, you'll receive a lump sum payment once you've been approved by your financial institution. Unlike a line of credit, a personal loan has a fixed interest rate that's based on Canada's prime rate, meaning that you will have the same interest rate throughout the entirety of your repayment schedule.

Most loans in Canada offer financing options that can range between $100 and $50,000. When it comes to repayment terms, these can range from six months to five years. Like a line of credit, a loan is unsecured, meaning you won't need to offer collateral. However, most financial institutions require a minimum credit score before they will approve you for the loan. That said, there are some credit unions that will approve loans for those who have poor credit scores as well.

The major difference between a loan and a personal line of credit is how you can access your money. If you're looking for an upfront payment and predictable interest payments, you may want to opt for a loan. On the other hand, a personal line of credit offers more flexibility but comes with some risk, given that your interest rates rise and fall with the prime rate.

Instead of a line a line of credit, should I consider payday loans?

If you've ever been strapped for cash, you may have considered applying for payday loans. However, these types of loans are something you'll generally want to stay away from. A payday loan is a type of unsecured, short-term loan that basically works as a cash advance until your next paycheque is deposited. In theory, you'll need to pay this loan back as soon as you get paid.

Simple right? What could go wrong? A lot, actually. Because these types of unsecured loans offer quick cash, people without sufficient income at the time don't realize that these loans have ridiculously high interest rates. So, when you go to pay back the loan, you'll owe a significant amount compared to what you borrowed in the first place. You're better off finding another solution, as mishandling a payday loan can dig you into a deep hole of of high-interest debt that is difficult to get out of.

What is the highest credit limit you can get for a credit line?

The maximum credit limit someone can secure really depends on the type of credit line they're applying for, their credit history, and whether they're going the secured or unsecured route. For example, if you're new to Canada, your credit history as a newcomer starts at zero, which is why building credit responsibly will help you in the event you need to apply for a credit line in the future.

Now, if you have an extensive history and a lot of collateral to put on the line, you can realistically get up to $100,000 or more, depending on the circumstances.

Do you pay interest on a line of credit?

Yes, as with any other type of you will need to pay interest on your lines of credit. However, with lines of credit, you only need to pay interest on the money you borrow rather than the credit limit you're approved for.

For example, if you have a credit limit of $50,000 and only spend $15,000, you'll only need to pay interest on that $15,000. Another key feature that lines of credit offer to borrowers is the flexibility of making a minimum payment each month. These interest-only payments are there to help borrowers in the event they are tight on cash and aren't able to make a principal payment some of the time.

Can I have a line of credit and not use it?

Absolutely, you can! A lot of Canadians get approved for a line of credit and keep it as a backup in case something unexpected happens and they need money to pay for major bills. Because you only pay interest on what you borrow, you won't get charged anything from your lender until you withdraw from that account.

As a disclaimer, depending on who you have your line of credit with, there may be hidden maintenance or inactivity fees should you choose not to use your loan. So, make sure to read the terms and conditions of your agreement documents before signing anything. That way, you aren't charged for money you haven't used.

Get your line of credit with KOHO

When it comes to borrowing money, a line of credit is a great option for those looking for freedom and flexibility. With secure and unsecured lines, collateral can help you obtain higher credit limits, depending on your needs. But, like any loan, it's essential that you weigh your options beforehand.

At KOHO, we help Canadians take control of their finances. Whether you're looking to achieve a high credit score by applying for a virtual credit card or save for the future using one of our high-interest savings accounts with overdraft protection coverage, we've got numerous products and resources to help you along the way.