Personal loans can be a financial lifeline for the everyday Canadian, offering quick access to funds for everything and anything—from a big purchase to a small emergency expense.
While a personal loan has several benefits, they also carry some inherent risks.
Understanding the pros and cons of a personal loan can help you make informed decisions on the right financial tools for your situation.
What Is A Personal Loan?
To understand the pros and cons of a personal loan, you need to understand what is a personal loan, and how it works.
Personal loans are among the most basic and straightforward types of loans. They are simple contractual arrangements between a borrower and a lender, in which the lender extends a certain amount of money to the borrower upfront. In exchange, the borrower repays the lender the money borrowed in fixed installments over a set period of time, with interest.
The lender assesses the borrower’s riskiness and determines the level of interest. A borrower with limited income, assets, and a poor credit history will generally be charged a higher interest rate than someone who has a steady job, assets, and a strong credit score.
Learn more: Best Personal Loans In Canada
Pros And Cons Of A Personal Loan: An Overview
Personal loans offer great advantages and flexibility but also come with some drawbacks.
Here’s an overview of the pros and cons:
| Pros | Cons |
| – Fixed repayment terms – Potentially lower interest rates than credit cards – Can be used for almost anything including debt consolidation and emergency expenses – Builds credit when managed responsibly – Flexibility for large purchases or emergencies | – Individuals with bad credit may be charged high interest rates – Fees (ex: origination fees and penalties) – Risk of overborrowing – Missed payments can harm credit score – Financial inflexibility during the repayment period |
What Are The Benefits Of A Personal Loan?
As mentioned, there are many benefits of a personal loan. While some may be obvious, there are other less common ways a personal loan can come in handy.
1. Save Money By Consolidating Debt
One of the most common uses for a personal loan is consolidating high-interest debts, such as credit card balances. By replacing multiple payments with a single loan at a lower interest rate, you can save money and simplify your finances.
For example, many credit cards have interest rates exceeding 20%, while personal loans often offer rates between 9.99% to 35% for qualified borrowers.
Learn more: Debt Consolidation Loans
2. Spread the Costs Of Large Purchases
Personal loans are ideal for significant one-time expenses, such as home renovations, weddings, or a new vehicle. Instead of draining your savings, you can spread the cost over a fixed period with manageable monthly payments.
3. Overcome Financial Setbacks
In times of financial hardship—such as job loss, medical emergencies, or unexpected home repairs—a personal loan can provide the cash you need to stay afloat.
However, it’s crucial to ensure you have a realistic repayment plan in place before you take the payout.
4. Build Credit
When used responsibly, personal loans can boost your credit score by adding to your credit mix and demonstrating consistent repayment. Timely payments signal reliability to lenders, potentially improving your credit profile over time.
Learn more: Best Programs To Help You Build Credit In Canada
5. Personal Loans Can Help During Different Life Stages
A personal loan can also be helpful to individuals in different circumstances:
For Young Professionals and Students
Personal loans offer quick access to funds for emergencies, education, or starting a business. Used wisely, they can also help students and young professionals build credit.
Do note, high interest rates and the risk of overextending financially can burden young borrowers before they’ve established a stable income. Interest rates are affected by credit history, which is limited for younger individuals.
For Retirees or Pre-Retirees
Personal loans can help retirees pay off lingering debts or manage unexpected expenses, reducing financial stress during retirement.
Fixed incomes can make repayment more challenging, and borrowing at this stage may indicate deeper financial issues.
Learn more: How To Get A Loan When You’re Retired
What Are The Risks Of A Personal Loan?
- High Interest Rates: Borrowers with poor credit may face interest rates upwards of 20%, negating the benefits of the loan.
- Additional Fees: Origination fees, late payment penalties, and prepayment penalties can increase the total cost.
- Credit Score Impact: Missed payments can damage your credit score and lead to debt collection.
Additional Risks To Consider
High interest rates, fees and the potential negative impact on your credit score are some of the more obvious risks of a personal loan. However, there are several other risks you should be aware of:
- Reduced Financial Flexibility: Loan repayments can tie up a portion of your income for months or years, limiting your ability to save or spend on other needs.
- Mental Health Impact: Financial stress from managing debt can affect mental well-being. Having looming bills or the inability to make a loan payment creates a lot of unnecessary stress.
- Risk of Overborrowing: At first glance, it seems easy to gain access to the funds. This may lead to borrowing more than you can afford to repay, creating a false sense of financial freedom.
- Changing Financial Circumstances: A job loss or medical emergency during the loan term could affect your ability to repay.
When Should You Get A Personal Loan?
The best time to take out a personal loan is when you have a clear plan for its use and repayment. Ideal scenarios include consolidating high-interest debt, spreading out the cost of a necessary purchase, or covering unexpected expenses.
Ensure that the monthly payments fit comfortably within your budget and that the total cost of borrowing aligns with your financial goals.
Tip: It is strongly recommended that you create a budget to ensure that the monthly expense of the personal loan is manageable before taking out a personal loan. This can cut down the risk of overborrowing and potentially missing a payment—and consequently damaging your credit score.
Alternatives To A Personal Loan
- Buy Now, Pay Later (BNPL): Ideal for smaller purchases, BNPL plans allow you to split payments over several months, often with no interest if payments are made on time. There are many new service providers that accomplish this, including Paybright and KOHO.
- Low-Interest Credit Cards: Balance transfer credit cards with introductory 0% APR periods can help you consolidate debt without incurring interest—provided you pay off the balance before the promotional period ends.
- Home Equity Loan: If you own a home, a home equity loan or line of credit (HELOC) may offer lower interest rates and larger borrowing limits. However, your home serves as collateral, increasing the risk if you default.
Bottom Line
Personal loans can be a valuable financial tool for Canadians when used wisely. However, they also come with risks that you should be aware of, including high interest rates and added debt.
Before taking out a personal loan, evaluate your financial situation, explore alternatives, and ensure you have a solid repayment plan.
If you don’t absolutely need to incur the expense or you can find a way to make the purchase by saving—this may be a better alternative than taking on an extra debt burden.
