The Loans Canada team sits down with Gary Schwartz of the Canadian Lenders Association to talk about open banking.
Loan Types For Credit Users
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When you’re a budding credit user, it’s important to learn about the characteristics of different loan types. Fortunately, there are plenty of loan types out there, suited to all kinds of financial necessities. There are mortgages to buy houses, vehicle loans for cars, short-term loans and credit cards for general expenses, and consolidation loans to help with debt problems. No matter what your financial situation looks like, there’s usually a loan somewhere that might suit you.
What is consolidation and how can it help your financial situation? Find out here.
Unsecured Loans vs. Secured Loans
Firstly, let’s take a look at the two main loan forms that you’re likely to encounter during your hunt for the right loan/credit product, known as “unsecured” and “secured”. Keep in mind that each form has its own merits and downsides.
These loans are, in a sense, more common. They’re called “unsecured” because they aren’t secured against an asset, meaning pieces of property you own that are of significant value (your car, house, a plot of land, etc.). In other words, an unsecured loan doesn’t require any physical collateral or security to be approved, which is one of their main benefits. So, if you start falling behind on your loan payments, you’ll run the risk of racking up a bunch of late penalties and heightened interest fees, but you won’t lose any assets. The reason unsecured credit products are generally more common is that while not everyone has a mortgage or a car loan (which we’ll discuss below), almost everyone over the age of 18 has at least one credit card in their wallet these days. Credit cards are the most frequently used unsecured credit product, right next to lines of credit, small short-term loans, etc.
Check out the difference between a personal loan and a payday loan.
Since no collateral is involved, when you apply for an unsecured loan, your creditworthiness will be based on your financial health and credit score. In other words, the likelihood that you’re going to pack back your loan on time and in full. Depending on the size of the loan you want, you’ll need to back it up by having a solid source of income and a good credit score, credit history, credit report, etc. Unless, of course, you’re getting your first credit card and have no credit history yet. In that case, a stable income is usually the minimum requirement.
Want to know what happens when you stop paying your credit card bills? Read this.
The main downside to an unsecured loan is that, since there is no collateral to secure it, lenders will usually charge a higher interest rate to justify the money they’re lending. That’s why you have to be very careful when using unsecured credit, being that the most common kind of debt stems from credit cards. A lot of consumers charge every expense to their credit cards because they don’t have to pay them immediately out of their bank account. This causes them to reach their credit limits very quickly. If you, as the credit user, start overspending and missing loan payments, your property won’t be seized, but your debt might be sold to a collection agency.
Contrarily, secured loans do require you to put forth assets before you’re approved. Since this form of credit generally refers to significantly larger amounts of loan money, banks and other lenders require a strong enough incentive to put forth the investment. Secured loans are frequently seen with products like mortgages and car loans, which can cost tens, even hundreds of thousands of dollars.
Are your mortgage rates increasing? Here’s what to do.
While the interest rates for secured loans are lower, the use of collateral their biggest downfall. If a borrower does not follow their repayment plan, the lender is legally entitled to seize their asset as collateral. Under certain circumstances, they may hold the asset until they’re paid back completely. However, if it looks like the borrow won’t follow through, they also have the right to sell the asset to recuperate their loss.
This is why it’s very important if you’re applying for a secured loan, to really consider the consequences. If you default on an unsecured loan, the punishment will be interest rate hikes and mounting penalty fees, followed by a drop in credit score, possible legal action, and wage garnishment. In that case, if you work hard enough, you can eventually rid yourself of the debt using money alone. With a secured loan, however, not only will your credit score be damaged if you default (making it harder for you to get approved in the future), but your house, car or other property might be taken away.
To learn about the foreclosure process in Canada, look here.
Common Loan/Credit Product Types
Now that you know more about the two common loan forms and what happens when you don’t use them responsibly, let’s delve into the loan and credit products that are frequently seen amongst everyday borrowers.
This credit type refers to loans that are “installment-based” when it comes to their repayment schedules. They’re common with, but not limited to car loans, mortgages, and other types of larger personal loans. Here, rather than having a revolving credit system (which we’ll discuss just below), the borrower has a regime to adhere to until their loan is paid in full, which is made up of regular, equally-sized payments. These payments might be monthly or bi-monthly, weekly or bi-weekly, etc.
Installment loans can be a “closed”, meaning you can’t pay more than the specified amount every payment. While cases are rarer, some installment loans can also be “open”, meaning you can increase your payment amounts if you want, paying off the loan quicker. Before you apply, ask your lender about these options, as some lenders don’t allow advanced payments, since they wouldn’t be making as much in interest. Once again, be very careful with your installment loans, because while the interest rates are generally lower, the consequences for defaulting on your payments are worse.
Shopping for low-interest rates? Read this before you go looking.
When you have a fixed amount of credit for a loan product, the limit of which renews itself once you pay it off, it’s known as “revolving”. Some of the more familiar revolving credit products include credit cards (both regular and retail-location cards), lines of credit, and HELOC (home equity lines of credit). As we said, here you’ll have a specified credit limit. As you pay back what you owe, your limit will return to what it was originally.
Looking to borrow using your home equity? Check this out.
For instance, Sam goes shopping and charges $100 to her credit card, which has a credit limit of $1,000. She’ll then have $900 of available credit left. However, once she pays her monthly bill of $100, assuming she pays it in full, this amount will automatically be transferred back to her credit card for further use.
With revolving loan products, the payments vary according to your spending. While they usually come with high-interest rates, they afford the user a grace period, during which they can gather the necessary funds to pay off their balance before interest rates get applied. The problem, in a sense, with revolving credit is that the products involved also come with a minimum payment that the user can stick to. This can be beneficial if the user can’t afford to pay their full balance but wants to avoid a penalty fee. However, retail interest is charged for every dollar that goes unpaid, which can cause a “revolving” cycle of debt that will only get worse if the user continues to follow a minimum (or just above minimum) payment regime.
To learn about the minimum payment trap and how to avoid it, click here.
While this style of loan product is more or less installment-based, it needs to be put in a category of its own. Generally, payday loans are for relatively small amounts, often less than $1,000-2,000. Borrowers should only use payday loans as a last resort to immediately cover a pressing expense, such as their rent or another financial emergency.
We can’t stress this enough, if you’re thinking about applying for a payday loan, be very cautious and realize what you may be getting yourself into! Payday loans come with extremely high-interest rates and expensive fees, sometimes as much as 400% APR (annual percentage rate). More often than not, payday lenders are out to take advantage of borrowers in desperate situations, because they don’t have a good income or didn’t qualify with their bank, and therefore have no other option.
Want to find some debt relief for your payday loans? Click here.
Yes, it’s easy to get approved for a payday loan. Unlike regular loans, all you need is proof of your address, employment/income, and that you have an active chequing account. Once you’re given the money, you’ll have until your next pay-day (usually 2 weeks) to return the total loan amount, plus those high-interest charges. In some cases, the borrower will get stuck in a vicious debt cycle when they can’t afford to pay back the loan in full by their original due date. In fact, many places in North America are trying to ban payday loan lenders because of the serious debt they can cause.
If you don’t understand the payday loan cycle, take a look at our infographic.
Another option for some borrowers that’s far less risky than any payday loan is the “guarantor” loan. This involves finding a co-signer as a way to enhance your application when your own financial profile is not up to your lender’s particular standards (i.e. you have bad credit, a low income, or other factors that typically get your applications denied). Your co-signer would have to be strong financial candidate, meaning they have good credit, a high income, etc. This option can be beneficial to you, because your credit will no longer be an issue. Instead, your guarantor’s credit will have the most influence during the approval process. However, as you continually make timely, full payments, you will see your credit improving, hopefully to the point where you would no longer need a co-signer.
Wondering if a guarantor loan is right for you? Make your decision after you read this.
It should be noted, however, that your guarantor/co-signer will become responsible for your loan, if and when you default on your payments for too long. This means that they will need to continue with your payments until the loan term has concluded. Not only can this cause them unwanted stress and debt, it could damage their finances if they also can’t make their loan payments on time.
Here’s what happens if you or your guarantor can’t make your loan payments.
Where Can You Get a Loan?
Generally speaking, most borrowers get their loans and other credit products through their bank or credit union, or with another traditional financial institution. However, there are also a variety of alternative lenders (online, privately owned, etc.) out there that provide loans based on all kinds of financial needs. Since banks have strict rules concerning which borrowers are qualifiable (i.e. they need good credit, a reasonable income, and net worth, etc.), the financial world has seen a growth of alternative lenders in recent years.
Borrowers can also seek out “indirect financing” for various purchases. For example, when a retail company offers the option of financing to buy an expensive item, such as a fridge or other appliance. This way, you could pay off your item through installments, rather than all at once. Keep in mind here that there is always a third party between the lender (the retailer) and the borrower, such as the bank the retailer does business with.
Click here to find out how you can get the best personal loan for you.
Speak to a Professional
Remember, every credit product should be considered a serious responsibility, whether it’s for a $400,000 mortgage or a simple first credit card. Many borrowers get themselves into serious debt trouble when they don’t handle their credit/loan products responsibly. Therefore, it’s always a good idea to speak to a professional financial advisor before you go about trying to get approved for a loan.
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