The cost of living is rising faster than the rate of minimum and median wages in Canada. Making it not uncommon for Canadians to turn to credit and loans to cover unexpected expenses and large costs. However, just because borrowing is becoming more commonplace doesn’t mean you should approach the lending process lightly. Whatever your need for fast cash may be (car repairs, rent payments, health expenses, etc.), know that taking out a loan is a significant financial decision. Be smart and do your homework before choosing to take on more debt.
How Personal Loans Work
First and foremost, it’s important to note that a personal loan is not a revolving line of credit; it is an installment loan to borrow a fixed amount over a specific period, typically 12 to 84 months. To pay back the loan, you make installment payments, plus interest, every month over the life of the loan. Once you’ve paid off the loan, the lender closes your account. If you need more money, you must reapply for a new loan.
Types of Personal Loans
There are two types of personal loans: secured and unsecured. You may qualify for an unsecured loan if you have a steady repayment history and make a decent living. However, unsecured loans come with higher interest rates, as the lender has more to lose if you default.
Secured loans are more favorable, as they mean less risk for the lender and lower interest rates for you. To obtain a secured loan, you must put an asset up as collateral, such as your home or vehicle. You should only take out a secured personal loan if you are certain you will be able to make the monthly installment payments without issue.
Why You Need the Money
You should not view personal loans as an ongoing form of credit. Cash loans are for emergency use only and should only be used when there is no other option. Before you request a cash loan from a banking institution or online lender, consider your motivations for doing so. Are you in a tight spot and need cash to cover the cost of medical expenses, car repairs or other essential expenses? Or do you just really want something, such as a new vehicle, television or trip to the Bahamas?
If the expense is a want, nix the idea of a personal loan entirely, as using a loan to spend beyond your means is irresponsible. If the expense is a need, ask yourself how pressing said need really is. If your car is broken down and you can’t afford to have it fixed, is it possible to use public transportation until you can save enough to pay for repairs? Consider your motivations for wanting to borrow cash. If, after doing so, the need is still there, move onto the next step.
Decide How Much You Can Afford
You need the money, and borrowing it is in your financial best interests. If that’s indeed the case, calculate how much you can realistically afford to pay back.
The word “afford” is tricky, as most people, on paper, can afford a sizeable loan. However, when you throw in the everyday expenses that most lenders do not take into account, such as gas, groceries, daycare costs and fluctuations in heating and cooling bills, monthly loan payments become more oppressive and, for many, unmanageable.
Before going to a lender, write down ALL of your expenses and not just the “official” ones. If you spend $5 on coffee every day, and intend to continue doing so, add $140 to your monthly budget. If you buy diapers every two weeks, add another $80. Be honest with yourself and the lender, it will ensure you do not get in over your head with loan payments.
APR and TAR Are Not the Same
The annual percentage rate is a lender’s favorite tool. Many lenders will tack a lower APR onto a loan with a longer life and vice versa to entice those strapped for cash. The loan with the longer life also happens to come with a lower monthly payment, which is a bonus. Before you jump at the loan with the smaller figures, though, consider the TAR, or total amount repayable. To show you why TAR is more important than APR, consider the following example:
- Option A: $5,000 at 5.00% APR for five years = A monthly payment of $94.36
- Option B: $5,000 at 6.00% APR for two years = A monthly payment of $221.60
With option A, you have a lower APR and monthly payment, but ultimately, you will end up paying $5,661.37 over the life of the loan. Option B, however, breaks down to a TAR of $5,318.49, which means you’ll pay less than half the interest of that associated with Option A.
Cash loans certainly serve their purpose, and they’re an excellent option for those who face unexpected expenses. However, if you choose to use a cash loan, be smart, do your homework and discuss all your options with a reputable lender.