4.2.2 Credit options

From: Financial Consumer Agency of Canada

This chart summarizes the main features, advantages and disadvantages of different types of credit.

Type of credit

How it works

Advantages

Disadvantages

Personal loan from financial institution (bank, credit union, caisse populaire or trust company)
  • A loan from your financial institution directly to you
  • Suitable for medium- and longer-term needs, such as buying a car or paying for home improvements
  • If you get a loan with an open repayment schedule (as opposed to one with a fixed schedule), you may be able to increase your monthly payment or make a lump sum payment to pay off the loan sooner with no extra charges
  • Because of interest, your purchase will cost more than if you had saved up the money before buying

 

Line of credit
  • A type of pre-approved loan that allows you to borrow money when you need it, up to a maximum amount

 

  • Allows you to borrow, repay and borrow again based on your credit limit
  • Often has a lower interest rate than other credit products such as a credit card advance or account overdraft, and different repayment options, particularly if it is secured by the equity in your home
  • The interest rate is often not fixed and can rise.
  • The minimum payment is interest only, and there is often no repayment schedule, which may make it harder to pay off the debt completely.
Overdraft protection
  • A service that financial institutions offer on chequing accounts, which allows the account holder to access additional funds beyond what is on deposit—but the funds must be repaid within the statement period
  • Is convenient if you are short of money in your account at a particular time (e.g., if a bill is due just before your payday)
  • Interest charges can be very expensive.
  • You could be charged penalties if you do not repay the loan in full and on time.
Auto company loan
  • A loan for the purchase of a vehicle arranged through the car dealer's financing company
  • The car is collateral and can be seized and sold if you don't pay as agreed.
  • May offer lower interest than loans from financial institutions
  • Depending on the down payment and how the vehicle depreciates, the value of the loan could become greater than the value of the car.
Student loan
  • A bank loan for education costs with a special rate and special repayment terms for students
  • Sometimes guaranteed by the government
  • Interest rates are lower than for personal bank loans.
  • You don't have to start repaying the loan until you finish your education.
  • You could graduate with a great deal of debt.
Mortgage
  • A type of loan often used to buy a home or other property. Your home or property is the security or guarantee for the loan.
  • Allows you to make the largest purchase that most people ever make
  • Different terms (loan period, interest rate, payment schedule, etc.) are available, adding repayment flexibility
  • Often available at lower rates than consumer loans
  • You must get mortgage insurance if you have less than 20% of the value of the home as a down payment, which increases the cost of the loan.
  • You could lose your house if you do not make the mortgage payments.
  • Most mortgages require a lawyer, title registration and a survey, which add to the cost of buying a house.
Credit card
  • When you make a purchase, you borrow money from the credit card issuer to pay the vendor, and you have to pay back the money you've borrowed by a due date.
  • For credit card purchases, if you do not pay the purchase balance in full each month by the payment due date, you incur interest charges.
  • You may also use your credit card for cash advances. Interest on cash advances is charged right away. The card issuer sets a credit limit (the maximum amount that you can charge on the card before paying off the charges); limits vary with your income, your credit rating and the amount of debt you have.
  • Lets you borrow money instantly to make purchases
  • Allows you to carry less cash
  • Lets you get cash advances (but you start paying interest right away)
  • Can be more convenient, and more widely accepted, than cheques
  • Has an interest-free grace period on new purchases, provided that you pay the balance in full by the current month's due date
  • Lists your purchases in one statement so you can track your spending and check for any fraudulent purchases
  • If you do not receive what you paid for or if the transaction is fraudulent, you may ask the card issuer to reverse the charge
  • May offer extended warranty or purchase protection on purchases as well as other rewards and benefits
  • High interest charges add to the cost of a purchase if you don't pay the balance in full by the due date.
  • Interest varies from about 10% to 30%, depending on the type of card and the type of transaction. This is much higher than many other types of credit.

 

Deferred payment plan
  • A purchase plan in which you can delay paying for a purchase for a specified time, usually by paying the amount in instalments, with interest
  • Often offered by appliance and furniture stores
  • Allows you to buy things immediately without having to wait to save up the entire purchase amount
  • Usually charges very high interest rates and fees
  • Some plans offer "0% interest" for a period of time, but if you don't pay by the due date, you have to pay high interest from the date you made the purchase
Rent-to-own contract
  • A type of loan in which you rent an item (usually furniture or appliances) for a defined period of time.
  • You have the option of purchasing the item by continuing to pay the rental fee over time or by paying a lump sum.
  • You do not own the item until the last instalment of the loan is paid.
  • Allows you to use the rented item without waiting to save up the entire purchase amount
  • Can take a very long time to pay off and is often extremely poor value for money
  • You can end up paying much more than the actual purchase price.
Payday loan
  • A short-term loan that you promise to pay back from your next paycheque
  • Offered by payday loan companies and by most cheque-cashing outlets

 

  • Provides quick access to cash
  • May not be regulated by the government
  • More expensive than alternatives
  • Charges very high interest rates and fees
  • Your next paycheque may always be used to repay the current loan.
  • Does not improve your credit history since payday lenders don't report to credit bureaus
Secured credit card
  • A card that requires you to provide the card issuer a security deposit before the card is issued
  • Your credit limit is normally set as a percentage of your deposit (usually 100% or more).
  • Could be useful if you have no credit history in Canada, you've had credit problems in the past and want to rebuild your credit rating, or you've filed for bankruptcy in the past
  • Most issuers pay interest on your security deposit
  • Normally has a higher interest rate than an unsecured card if you have no credit history or bad credit
  • May charge annual fees, application fees and other charges
Informal loan
  • Money that you borrow from a family member or other individual
  • With larger loans, it's valuable to have a formal agreement.
  • Provides quick access to cash if you have no alternative source of funding
  • Family members may charge low or no interest
  • Some informal loans come through “loan sharks,” people who lend money at exorbitant or illegal rates of interest.
  • Can cause relationship problems if there is a misunderstanding on the terms or if you have difficulty paying back the loan
High-risk or approved loan
  • A type of unsecured loan that you may apply for if you are turned down for a personal or other loan by a financial institution
  • May be issued by auto loan financing companies, retail stores, mortgage lenders, etc.
  • Often used by people with poor credit for short-term emergency loans
  • Can improve your credit rating if you pay off the loan on time and in full
  • Lenders do not usually ask for collateral
  • The application process is usually quick and simple
  • Usually has a higher interest rate and higher fees than other loans, as well as stricter terms

 

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