Why Homeowners Can Borrow at Lower Rates Than Renters

Not everyone plays by the same financial rules.

Homeowners and renters participate in the same credit system. They can apply for credit cards and loans to access funds, and they’ll both pay interest if they need to pay back their loan over time.

But homeowners have access to a separate layer of lending that doesn’t exist for renters. Homeownership unlocks secured borrowing. In many cases, this structure can unlock lower interest rates. Here is why.

What is the difference between secured and unsecured debt?

Loans generally fall into two categories: secured and unsecured debt.

Secured debt is backed by an asset. A mortgage uses a home as collateral. An auto loan is backed by a car’s value. With other secured loans, a borrower can pledge stocks, bitcoin or even a recreational vehicle or boat. If the borrower doesn’t repay their loan, the lender can take the collateral and sell it to cover any unpaid balance and expenses. Any proceeds left over from the sale are then given back to the borrower.

Unsecured debt, such as most credit cards and personal loans, has no collateral. Lenders take on more risk because there is no asset to recover if a borrower stops paying.

What is the difference for homeowners?

Homeowners can borrow against the equity value of their home through a home equity line of credit, or HELOC.

A homeowner can convert some of this home equity into a revolving line of credit with a HELOC. They don’t need to sell their home to borrow or access funds, but they do have to pledge their home to back the line of credit.

What is home equity?

Home equity is the difference between a home’s market value and any outstanding mortgage balances. It can grow over time as the mortgage is paid down and as property values increase.

For example, if a home is valued at $300,000 and the homeowner owes $200,000 on the mortgage, the homeowner has $100,000 in home equity.

Why collateral changes the rules for credit

Lenders want to make sure they are paid back. They typically use credit scores, income, assets and other factors to estimate whether a borrower will repay, and, as a result, who to approve and what interest rates to charge.

Collateral reduces a lender’s risk of loss. Lenders can generally offer lower interest rates, larger loan amounts or credit limits, or longer repayment periods with secured loans.

A HELOC allows a homeowner to draw from their line of credit over a set period of time. A homeowner can borrow, repay and borrow from the HELOC again, like a credit card but secured by home equity.

Why renters face a different credit system

Renters can’t get a HELOC because they don’t have any home equity to use as collateral. Instead, they usually have to rely on other credit products, such as unsecured loans.

Lenders face higher expected losses with unsecured loans because there is no asset to sell to recover any losses. The higher risk shows up as higher interest rates for the borrower.

As a result, two people with similar earnings can face very different borrowing options depending on whether they own a home or have an asset to pledge.

The bottom line

Homeownership can expand access to lower cost credit. A homeowner can borrow against their home equity with a HELOC. Because secured loans carry lower risks for lenders, they often come with lower interest rates than unsecured credit.

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This post is for informational purposes only and does not provide any financial, investment or tax advice. The information presented may not be suitable for your individual circumstances. Before making any financial decisions, consider consulting a qualified professional who can provide advice based on your specific situation.