At some point in our lives, we will all need to borrow money. To buy our first home, to get the vehicle we need, to cover the cost of an emergency, to pay off high-interest debt, the list goes on. Not only is borrowing money (responsibly that is) an integral part of maintaining a healthy financial life, it affords us the opportunity to purchase or experience something that we wouldn’t otherwise be able to afford to pay for with cash. With that being said, there are countless ways to borrow money, both good and bad. So, how do you choose the right way to borrow the money you need?
The Best Ways to Borrow Money
No matter why you need a loan or what you’re going to use it for, you’ll be faced with both “good” and “bad” options. Although, we’ll add that everyone’s financial situation is unique to them, so a certain loan may be a great option for you, but a not so great option for someone else. Generally speaking, the following are the best ways to responsibly borrow money.
Learn how to get approved for a personal loan here.
Unsecured Personal Loans
If you need to cover an unexpected expense, are looking to make a large purchase, or want an affordable repayment schedule, then an unsecured installment loan might be exactly what you need (learn more here).
What is a Personal Loan?
An unsecured personal loan is a cash loan that can be used to purchase whatever the borrower needs, unlike say a mortgage or car loan that is used to pay for a specific item. There are many different types of lenders who offer personal installment loans, including banks, private lenders, and online lenders. If you decide to apply for a personal loan from a bank, you’ll more than likely need to go through a credit check and have a credit score that is average to high. On the other hand, if you decide to go with a private lender or an online lender you’ll have more options.
Want to know more about credit scores? Take a look at this infographic.
What Does Unsecured Mean?
An unsecured loan is a loan that is not backed by collateral (a mortgage is an example of a secured loan where the house acts as the collateral). Typically an unsecured loan is provided based on your ability to pay it back. A lender is taking on more risk when they approve someone for an unsecured loan because there is no collateral to cover the cost of the loan should the borrow default. This is why the average unsecured personal loan is usually smaller in size and if you’re looking to get a larger unsecured loan you may need to consent to a credit check.
What will my Payments be?
All unsecured personal loans are different usually because they’re tailored to the borrower’s unique needs and financial situation. This means it’s difficult to give an exact estimate of what your payments might be. What we can prepare you for is deciding how frequently you want to make payments. Keep in mind that you might not be given the chose between the following options but you can choose your lender based on the payment frequency that they prefer.
- Weekly payments. You’ll make one payment a week for the duration of your loan.
- Bi-weekly payments. With this option, you’ll make a payment every two weeks.
- Twice monthly payments. You’ll make two payments a month with this option.
- Monthly payments. One easy to handle monthly payment.
The Difference between Bi-weekly and Twice Monthly Payments
It’s important to understand that bi-weekly does not mean twice a month. With twice monthly payments you’ll make 24 payments in a year (12 months in a year x 2 payments a year = 24). With bi-weekly payments, you’ll make 26 payments in a year because there are 26 two-week periods in a year (52 weeks in a year / 2 = 26).
The reason why you might want to choose bi-weekly payments over twice monthly payments is because you be paying back your loan quicker and therefore will also save some money on interest charges (the less time it takes you to pay off a loan, the less money you spend on interest).
Credit Cards
Credit cards are one of the most common and straightforward ways to borrow the money you need quickly. Most adults have at least one credit card and can easily apply and get approved for more. This is both a blessing and a curse for the majority of consumers. Ease of access when it comes to credit cards means it’s convenient to borrow money whenever you need it. Credit cards are also a great way to build and grow your credit; if that’s something you’re interested in. But, the convenience of a credit card also makes it extremely easy to spend money you don’t have, therefore creating debt you can’t afford to pay off.
The Minimum Payment Trap
When you use a credit card to make a purchase, you’re borrowing money that needs to be paid back within a certain period of time. This is exactly how a credit card should be used in order to minimize the creation of debt. But, since credit card companies are interested in making money (just like we all are); they provide you with an alternative option, the minimum payment. This is where you only need to pay back a certain percentage of your total balance before the end of your payment period, not the full balance. Sounds great right? While it can be a good options in certain situations (emergencies or if you need to pay for something important right away and don’t have the cash to cover it), it’s important to keep in mind that you’ll be charged interest on the remaining balance and will, therefore, owe even more the next month.
For more information on the minimum payment trap, read this.
A Line of Credit
Similar to a credit card, a line of credit can be used and paid off over and over again. A line of credit typically has a lower interest rate than a credit card (this is one of the biggest advantages of a line of credit) and is often used to pay off other higher interest debt. It’s just as convenient as a credit card and can be used to pay for anything. It also comes with a minimum payment like a credit card. But typically it’s in your best interest to make payments larger than the required minimum payment so that you don’t create too much debt for yourself.
The Best Way to Use a Line of Credit
A line of credit can be used in the same way as a credit card, to cover the cost of anything. But of course, it’s always better to use a line of credit to pay for something that will benefit you in the long run, instead of simply something you want. Here are a few of the best ways to use a line of credit to your advantage:
- To cover an unexpected expense
- To pay for repairs to your car so you can continue to get to your job every day
- To pay for a medical procedure or emergency
- To pay off other higher interest debt
Since a line of credit typically has a lower interest rate than a credit card, it’s may be a good idea for you to have a one available even if you have no need to use it right away. Although having money put aside in an emergency fund is the best way to protect your finances, a line of credit is also a great backup plan.
A Mortgage
A mortgage is a very specific way to borrow money, in that it is used to purchase real-estate. This could be a house, a farm, a piece of land, or any other type of building.
If you live in Canada and are interested in owning your own home, then it’s very likely that you’ll need to apply for a mortgage to do so. Typically a mortgage is one of the hardest loans to get approved for as there are many rules and regulations associated with this type of loan in Canada.
Saving For a Down Payment
Probably one of the most important steps in the home-buying process and one you can start working towards right away is saving enough money for a down payment (learn more about down payments here). In Canada, you need to put down at least 5% of the purchase price of the house you wish to buy, but 20% is recommended. Saving at much for a down payment as possible is the best way you can maximize the affordability of owning a house.
Check out this infographic for an in-depth look at the cost of buying a house in Canada.
A Home Equity Loan
If you’re a homeowner then a home equity loan is another great way to borrow the money you need. When a homeowner takes out a home equity loan they are using the equity from their home, the portion that they have paid off and actually own, to secure a loan. The amount you’ll be eligible for depends on the value of your home and how much equity you have accumulated. Home equity loans come with lower more manageable interest rates and therefore can be very useful in certain situations, including
- To cover the cost of a home renovation that will increase the value of your home
- To pay for repairs or damages to your house
- To pay off high-interest debt to save money on interest and become debt free sooner
Keep in mind that when you put up your house as collateral, you are also putting your home at risk should you default on your loan. This is something that you need to keep in mind if you’re thinking about applying for a home equity loan just to pay off your credit card debt.
A Car Loan
A car loan is a type of loan that is used to purchase any type of vehicle, from recreational to the more practical. Car loans are relatively easy to get approved for and can be provided by a number of different types of lenders, including:
- In-house financing from a dealership
- Banks
- Online lenders
Car loans are a form of secured loan (like a mortgage), the vehicle that you’re planning on purchasing acts as collateral for the loan. This means that should you become unable to make your loan payments anymore, you may need to give back your vehicle to cover the outstanding balance of your loan.
For everything you need to know about financing a car, check this out.
What is a Car Title Loan?
If you’ve ever heard of a car title loan then you might be wondering how it’s different from a regular car loan. A car title loan isn’t used to purchase a vehicle; it’s a loan that’s secured against a vehicle that you already own. It’s a great way to get a larger personal loan than you might be able to get without collateral and is a great option for credit constrained Canadians who are having trouble getting approved for a loan because of their poor credit.
Friends and Family
One of the easiest and potentially quickest ways to borrow money is to ask a friend or family member. Depending on whom you ask this option is either a great idea or a recipe for disaster, it depends greatly on you and who you ask to borrow money from.
The Worst Ways to Borrow Money
While you should always make your financial decisions based on your experiences and your needs, not all loans are created equal and therefore there are definitely a few ways of borrowing money that should be avoided.
Payday Loans
Payday loans are quick short terms loans that must be repaid by your next payday. They are an extremely convenient way to borrow money on the spot. Generally speaking, payday loans are easy to get approved for which makes that very attractive to consumers who are in desperate situations or who are dealing with financial issues. To get a payday loan you must provide a lender with:
- Proof of your address
- Proof that you have received a steady income for the last 3 months.
- Access to your chequing account so that the money can be deposited and payments can be automatically withdrawn.
Payday Loans: Know Your Rights, read here.
Payday loans are the most expensive way for a consumer to borrow money. They often have an APR of well over 500% and have such short terms that it’s often almost impossible for a borrower to come up the money needed to pay off the loan. Payday loans are a type of predatory lending; the financial stability of the borrower is not considered which can often lead to them becoming stuck in the payday loan cycle.
The Payday Loan Cycle
When a consumer takes out a payday loan, they sign a contract that stipulates that they will repay the loan in full plus interest by their next payday. What often happens is that the consumer is unable to repay their first loan and must take out a second loan to cover the first. This can sometimes go on in a vicious cycle for months if not years.
Check out this infographic to learn more about the payday loan cycle.
Credit Card Cash Advances
It’s more than likely that you’ve seen credit card cash advances on a list of good ways to borrow and we don’t necessarily disagree with this. It’s just that when you take a cash advance from your credit card, you’ll be charged interest right away. Furthermore, cash advances often have higher interests rates than purchases do (for more information click here). This means that if your cash advance interest rate is 21%, it’s like you’re taking out a loan with an interest rate of 21%.
The bottom line is if you can’t afford to pay off your cash advance right away then this is an extremely expensive way to borrow money.
From a Lender You Don’t Trust
Working with any type of lender that you don’t trust is never a good idea, whether it’s a more traditional lending institution or a smaller online lender. If you feel as though the lender does not have your best interests in mind or if a deal you’ve been offered sounds too good to be true, it’s completely within your rights to refuse to sign a contract and decide to choose a different lender to work with.
How to Spot a Loan Scam
While some lenders are actually in the business of working with people to provide them with the money they need, others are criminals looking to scam hard working consumers. It’s very important that you know how to spot a loan scam before you become the victim of one. Here are the most common ways to tell if a lender is a fraud.
- If it sounds too good to be true. Like we said before, if a lender offers you a great deal that seems just a bit too good, they may be trying to scam you.
- Guaranteed approval. No lender, no matter how good they are, can guarantee you approval.
- Upfront fees. It is illegal for a lender to ask you for any type of upfront fee, whether it’s for “insurance” or to help cover the cost of a loan. Never agree to give a lender any money before you receive your loan.
Borrowing Money When You Have Bad Credit
Credit constrained, bad credit, or subprime. Whatever you want to call it, there’s one thing we can all agree on, it sucks to get rejected for the loan you need just because your credit score isn’t high enough. Borrowing money when you have bad credit can often seem like an impossible task and it can be very hard to find someone willing to give you a second chance.
The good news is that the number of alternative lenders willing to work with credit constrained Canadians is constantly on the rise.
For more information on bad credit loans, click here.
How to Speed up the Borrowing Process
At the end of the day, borrowing money is a serious process that takes time and should not be rushed. There are steps that need to be taken to ensure that both the lender and borrower are protected, if this means taking an extra day to verify that you, the borrower, fully understand the contract you’re about to sign, then you should take the time. Equally as important, the lender should take all necessary steps to ensure that all potential borrowers can, in fact, afford the loan they’ve applied for.
It’s important that you have a good understanding of your financial situation if you don’t know what’s going on with your own finances; it may be difficult for a lender to take you seriously. Asking yourself the following questions before you decide to apply for a loan, should help you prepare for the loan application process.
- How much debt do you have?
- Are you carrying balances on your credit cards?
- Do you have all the necessary documentation in order?
- Are you willing to compromise on the loan amount, term, or other conditions?
Preparing to Borrow Money
All lenders are different and have their own ways of verifying someone’s financial health and creditworthiness, especially alternative lenders. This means it’s difficult to say what you need to take out a loan. But, or course, there are a few things that everyone who is interested in borrowing money should have.
- A chequing account
- A stable form of income(this doesn’t need to be a 9-5 office job)
- Regular access to a computer and the internet if you’re applying with an online lender
- A financial plan in place to repay the loan
It’s also very important that you are open and honest with your potential borrower, purposely lying or withholding information could cause long term financial issues for you, which may take years to correct or properly deal with.
It’s also important that you work with your lender. This means filling out the application fully and properly, answering their emails as soon as possible, following up with any missed calls you might have from them, and providing them with all the necessary paperwork and or documentation. If your lender needs something from you, but you don’t answer their emails or phone calls, you will hold up your approval and therefore it will take longer for you to get the money.
Choosing the Right Way to Borrow Money
As we discussed above, you should always make financial decisions, especially where borrowing money is concerned, based on your own needs, wants, income, and debt level. If you take into consider all that, you should have no difficulty borrowing the money you need in the most responsible way possible. If you’re interested in even more help or are looking to explore your option further, we’ve got you covered.
