What is a personal loan
With a personal loan, you borrow a fixed amount of money and agree to pay it back over a period of time. You must pay back the full amount, interest and any applicable fees. You do this by making regular payments, called instalments. Personal loans are also called long-term financing plans, instalment loans and consumer loans.
Personal loans are typically used for specific purchases such as home renovations, furniture and cars or to consolidate other debts with higher interest rates. Most personal loans range from $100 to $50,000 with a term between 6 and 60 months.
Personal loans are available from traditional lenders, such as banks and credit unions, as well as alternative lenders such as payday lenders, title loan companies, private lenders and pawn shops.
Your lender may offer you a loan for more than what you need. Be careful not to borrow more than you can pay back.
Make sure that the loan meets your needs. If your lender is a federally regulated bank, they must offer and sell you products and services that are appropriate for you, based on your circumstances and financial needs. They also must tell you if they’ve assessed that a product or service isn’t appropriate for you. Take the time to describe your financial situation to ensure you get the right product. Don't hesitate to ask questions and make sure you understand the personal loan you have or want.
How personal loans work
Here’s what you can expect if you’re considering a personal loan.
What you need to provide a lender
Generally, lenders will require proof that you have:
- a regular income
- a bank account
- a permanent address
Most lenders will run a credit check when you apply for a personal loan. Your credit report helps lenders evaluate your ability to repay your personal loan. They will likely consider your debts. Your credit report, credit score and debts may affect your loan options, including your interest rate and the type of loan you qualify for.
Getting your loan from a lender
Your lender will usually give you the money for your loan in one of the following ways:
- in cash
- deposited in your bank account
- sent to you as an electronic funds transfer
- sent to other lenders directly, if you are consolidating other debts
- on a prepaid card
If you decide to take the loan on a prepaid card, there may be a cost to activate and use the card.
Paying back a personal loan
With a personal loan, you agree to make regular payments. Most lenders will ask for your banking information so they can take the payments directly out of your account. This is called a pre-authorized debit.
Some lenders will send information about your personal loan payments to the credit bureaus.
If your lender reports to the credit bureaus, you can improve your credit score by making your payments on time. If you don’t make your payments on time, it may have a negative impact on your credit score.
You may be allowed to make extra payments or pay off your loan before the end of the term without a penalty. This will help you save on interest fees and pay off your loan earlier than planned. Some lenders may charge a fee if you pay off your loan early.
You may also be able to renegotiate the terms of your personal loan agreement with your lender. This can help you manage your budget if your financial situation changes. There may be a fee for this service.
Make sure you understand the agreement
Before you sign a personal loan agreement, make sure you understand the terms and conditions. Ask the lender about anything you don’t understand.
Federally regulated lenders like banks have to give you the following information when you take out a personal loan:
- amount of the loan
- interest rate and whether it’s fixed or variable
- payment amount
- other fees and service charges
- optional services you accepted
Other lenders, like some credit unions and alternative lenders, are under provincial or territorial regulation and may not be required to provide this information.
Types of personal loans
There are two types of personal loans.
A secured personal loan uses an asset, such as your car, as a promise to your lender that you will pay back the loan. This asset is called collateral. If you can't make your payments, the lender can take the asset from you.
There are various kinds of secured loans including:
- secured personal loans
- title loans
- pawn loans
An unsecured personal loan is a loan that doesn’t require collateral. If you don’t make your payments, the lender may sue you. They also have other options, such as the right of offset.
Many alternative lenders offer unsecured personal loans. These can be referred to as instalment loans or high-cost instalment loans. The interest rate on these loans is typically much higher than the unsecured personal loans offered by banks and credit unions.
How much personal loans cost
Don’t take out a personal loan unless you have the ability to pay it back. Borrowing money with a personal loan may cost a lot of money, depending on your interest rate, fees and when you pay it back. Consider your need for the personal loan. Ask yourself if you need the money now, if you can wait, or if you need it at all.
Shop around when considering a personal loan. To get the most competitive interest rate, get loan quotes from multiple lenders. Compare and negotiate fees such as administration fees.
Before you borrow, consider saving money for your purchase. By borrowing a smaller amount, you will save on interest fees.
When you take out a personal loan, your lender will give you a quote for a regular payment amount.
To get to this amount, they calculate the total cost of the loan which includes:
- the amount of the loan to be repaid
- the interest on the loan
- any other applicable fees
This amount is divided into equal payments.
How to compare loan options
It can be difficult to compare options for personal loans without knowing the total cost of the loan. You can calculate the total cost of the loan by multiplying the payment amount by the number of payments in your term.
Suppose you want to get a personal loan for $2,000. Assume the interest rate is 19.99% on a monthly payment plan. You may be offered various monthly payment options, which include interest and other fees.
For example, you have the following monthly payment options:
- option 1: $185 per month for 12 months
- option 2: $75 per month for 36 months
- option 3: $53 per month for 60 months
Lenders may extend the duration of the loan to lower your monthly payment. This comes at a cost because you’ll pay more interest over time. When you compare the total cost of the loan, it’s easier to know which option is best for you.
Table 1 shows the longer you take to pay off your loan, the more expensive it will be. The amounts are approximate and have been rounded to the nearest dollar.
The interest rate on a personal loan will impact the overall cost of the loan. By law, lenders may not charge more than 60% interest annually, which includes all fees, costs and interest that you’ll pay to get the loan.
Shopping around for the best interest rate might help reduce your costs.
The interest rate can vary depending on the following:
- your credit history
- the type of lender
- the type of loan (secured or unsecured)
Suppose you want to get a personal loan for $2,000 for 36 months and you compare the interest fees of the following interest rates:
- option 1: 8.99%
- option 2: 19.99%
- option 3: 39.99%
- option 4: 59.99%
Figure 1: Interest on a personal loan
Text version: Figure 1
|Option||Interest rate||Monthly amount||Total cost|
Figure 1 shows that the interest rate can significantly increase the total cost of your personal loan. The monthly amounts are approximate and have been rounded up to the nearest dollar. This example is for illustrative purposes only.
Before you take out a personal loan, consider the total cost including interest and fees. Depending on the terms of your personal loan you may end up paying more than double the retail price for an item.
You don’t have to take loan insurance with a personal loan. Your lender may offer optional creditor loan insurance for your personal loan. You must give your express consent to obtain this product. The lender can’t insist that you buy insurance.
Make sure that the insurance meets your needs in terms of protection. This type of insurance usually helps cover your loan payments in cases of illness, accident, death or if you lose your job. The terms of your loan insurance determine how much of your loan is covered.
The price of the insurance may vary based on your age and the amount of your personal loan. The price may also vary between lenders.
Federally regulated lenders, such as banks, can’t add optional loan insurance without your permission. If optional loan insurance has been added to your personal loan without your permission, contact FCAC to file a complaint. You should ask your lender to remove the optional services and reverse the changes.
Some lenders that are not federally regulated may add optional services and charge associated fees to your personal loan even though you may not have asked for those optional services.
It's important to read and understand your loan agreement. Ask your lender if anything is unclear.
What happens if you can’t pay back a personal loan on time
Before you take out a personal loan, you should consider your situation and your ability to pay it back.
There can be serious consequences if you don’t make your loan payment by the due date:
- your lender can request that you pay the full amount of the loan at once
- your lender might have the right to take something that you own, such as your car, if you have a secured loan
- your lender can report a missed payment to the credit bureaus, which could mean it will show up on your credit history and could hurt your ability to get credit in the future
- your lender will usually charge you a non-sufficient funds (NSF) fee if you don’t have enough money in your account to cover a payment that is supposed to be paid with a pre-authorized debit
- your lender could sue you for the debt
Act quickly if you are having trouble making repayments. If you can’t make the full repayment, pay what you can. Contact your lender without delay.
If you think your bank account balance won’t cover a loan payment, you can consider overdraft protection. This is a financial product that allows you to cover the amount of a transaction when you don’t have enough money in your bank account.
Getting electronic alerts from your financial institution
Your financial institution may send you an electronic alert when:
- the balance of your chequing or savings account falls below a certain amount
- the credit available on your credit card or personal line of credit falls below a certain amount
These alerts may help you manage your day-to-day finances and avoid fees.
Filing a complaint about your personal loan
If you have a complaint related to your personal loan, you should contact your lender.
All federally regulated financial institutions, such as banks and federal credit unions, must have a complaint-handling procedure in place.
Your lender may be regulated by a provincial or territorial government, for example alternative lenders and payday lenders. In that case, contact the regulator in your province or territory.
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