A personal loan is an amount borrowed from a bank or other lender, which is repaid by installments, including interest charges.
Not only can you shop for car insurance, life insurance, and mortgages online, but it's getting easier than ever to find personal loans from a number of lenders through the internet. There is a variety of options for you to choose from based on your financial situation and needs.
Types of personal loan
There are a number of different types of personal loans you can apply for through financial institutions or online:
- Secured personal loan. The amount you borrow is secured against some kind of collateral, such as a bank cash deposit, a car or real estate.
- Unsecured personal loan. If you have a good credit score and income you can avoid providing collateral to secure the loan.
- Fixed rate personal loan. The interest rate you are charged does not change during the loan repayment term.
- Variable rate personal loan. The interest rate may go up or down in line with changes in the lender's prime rate.
- Specific purpose loan. This includes car loans and student loans.
- Debt consolidation loan. Money borrowed via a personal loan can be used to pay off existing loan and credit card debt so that there is only one loan left to keep track of and repay, ideally at a lower overall interest rate.
- Unspecified purpose. You may need extra funds to purchase new technology or a home appliance, to go on a vacation, pay medical expenses or make home improvements. These, and many more, are all valid reasons for applying for a loan.
Features of personal loans
Loans have widely varying features, including flexible loan amounts and repayment periods, various interest rates, account-keeping fees and other charges, differing eligibility requirements, and the quantity of documentation required and turnaround time when applying for the loan. You'll need to take all these factors into account when deciding which loan to apply for.
Benefits of a personal loan
The best personal loans have some great benefits that approved applicants can take advantage of if they have good credit. This includes potentially lower interest rates than other types of borrowing, such as credit cards. Usually the difference in the interest rate between a personal loan and credit card is substantial enough to save you a lot of money when it comes to your monthly payment amounts.
After they review this interest disparity, people often use a personal loan to consolidate their debt. When the debt is moved from your higher interest credit cards and onto your lower interest personal loan, you're paying back the amount you owe faster because more of the repayment is going towards the existing balance and not each month's new interest charges.
Personal loans and credit scores
When you apply for a personal loan in Canada, the lender will do a credit check to make sure you're eligible for the loan. Your credit history contains details of your repayment activity for existing and past debts, as well as your monthly bills. This means that if you pay your bills and debts back on time, you're going to have a better credit score than if you missed a payment or were late paying a bill.
If you have a low credit score you will either get denied for the personal loan or have to pay a higher interest rate to get approval. To find the best personal loan for your needs at a lower interest rate, you should make sure your credit score is at least 650 before applying for the loan. However, it is still possible to get a personal loan with a credit score lower than this.
Personal loan alternatives
If you aren't sure a personal loan is the best choice for your needs, there are a number of alternative options for you to choose from. Check out these alternative options to see if one of them fits your situation better.
Line of credit
The nice thing about a line of credit is that you can apply for an agreed amount and have that balance to use as and when you see fit. You don't need borrow the full amount you were approved for all at once, as is the case for personal loans. Also, you're only charged interest on the balance you owe on rather than on the entire approved amount. A line of credit is suitable when you're not sure how much you will need to borrow, or if you're planning to make a series of smaller purchases over a long period — such as when doing home improvements.
Low interest credit card
A credit card with a lower rate is a great alternative to a personal loan because it allows you to earn rewards and build credit while giving you access to the money you need. Even if you don't have the best credit score, you may still get approved for a low interest credit card depending on the lender.
Balance transfer credit card
Many credit card issuers offer low promotional interest rates to applicants on balance transfers from existing loans and credit cards to their new card. You may be able to pay low interest — possibly no interest — on transferred balances for six months or even a year, but there may be a balance transfer fee to pay, of between 1% and 3% of the amount transferred. This method offers great repayment flexibility, but watch out for the high interest rate you may have to pay if you haven't fully cleared your debt by the time the promotional period expires.
Home equity line of credit
This type of loan lets you borrow against the equity in your house — that is, its market value minus the current balance owing on your home loan — and can be a good way to get a loan with a lower interest rate. Lenders will be expecting you to have at least 20% equity in your home.
You need to be confident in your ability to pay back the loan before going with this option, because the lender can initiate foreclosure if you default. You should also keep an eye on your mortgage interest rate to ensure it isn't about to increase before you take out this type of loan.