Need a Loan? Here's How to Be a Savvy Borrower

If you’re thinking about borrowing money to finance an upcoming purchase, it’s worth knowing how different financing options work.

You can’t change interest rates — which are painfully high right now — but you are in control of choosing the best available option, and Canadians have never had as many options as they do today.

Personal loans

If you take out a personal loan, you receive a lump sum amount from a lender. You repay the loan on a set schedule, often at a fixed rate and over a period of five years or less.

According to Matt Fabian, director of financial services research and consulting at TransUnion, a credit reporting agency, personal loan options have grown in recent years. One driver has been new lenders that have replaced stodgy applications with quick, online processes and near-instant approval.

Interest rates on personal loans are typically lower than credit card interest rates. You may find credit cards with zero-percent interest on balance transfers, but these usually require you to pay off the balance in six or twelve months — after that, the rate shoots up. Your ability to repay the balance in a given amount of time could be the deciding factor.

Buy Now Pay Later

In recent years, Buy Now Pay Later (BNPL) icons have been popping up in online checkouts alongside other digital-first methods, such as PayPal and Zillow. But, at its core, BNPL is simply a personal loan. Unlike traditional personal loans, however, in which you arrange the loan before buying something, BNPL offers are created instantly when you’re ready to buy and automatically tailored, down to the cent, to that specific purchase.

BNPL companies such as Klarna, Affirm and Afterpay have become popular due to their simple and speedy user interfaces. Another draw is the straightforward pricing. At checkout, you’re presented with a specific plan: four payments of $27.50 charged every two weeks, for example. If you put the same purchase on a credit card and plan to pay it off over a few months, it’s hard to know upfront what the true cost will be.

BNPL is particularly popular with younger shoppers. “They’d rather just know what they’re paying,” says Fabian. He says it’s easier for those who use these services to say, “I owe X amount of dollars every couple weeks, and then it’s mine.”

However, compared to personal loans, it’s harder to shop around for BNPL options. Merchants must first implement a BNPL payment method on their end, and the option they give you is the option you get. Some credit cards offer BNPL options — often called installment plans — directly to consumers, but they might be limited to specific merchants, have minimum spend amounts or require you to figure out the payment details before you purchase.

Finally, BNPL companies are fully aware of the impact their product has on consumer behavior: BNPL users spend more money, more often. If you work hard to find the lowest-cost form of financing only to blow your budget, you’re not coming out ahead.

Lines of credit

A line of credit is like a credit card, but without the physical card. It’s a form of revolving credit, which means you’re approved to borrow multiple amounts at any time, as long as the outstanding balance doesn’t exceed your credit limit. Plus, you aren’t committing to borrow anything upfront.

Interest on lines of credit is variable, which means it rises and falls with a lender’s prime rate. If you borrow money when the rate is 10%, and then rates jump to 12%, you’ll pay more in interest. If they fall, though, you’ll pay less. Rates for lines of credit are generally lower than credit card rates. They’re often lower than personal loans, too, but there’s always the risk that rates will rise.

How to save money when borrowing money

Are you willing to use collateral? You can expect better rates and a higher loan limit with a secured loan, which requires collateral, such as a home. If you don’t meet the repayment terms, the lender can take the collateral. Unsecured loans don’t require collateral but come with a higher interest rate.

Make lenders compete for your business. A good credit score is always a great setup for a good rate, however, it puts you in a particularly strong negotiating position in today’s banking environment. Banks have tightened their lending standards in response to higher rates. When businesses compete for a smaller pool of customer business, those customers tend to win — with a strong credit score, you’ll ensure you’re in that pool. Get personal loan rates from multiple lenders, look beyond the Big Six banks, and don’t be afraid to follow up with lenders to see if they can beat the best rate you initially received. (Note: Only bigger banks tend to offer lines of credit, Fabian says).

Consider why you’re borrowing. Whether a rate is a good rate depends in part on why you’re borrowing. A 10% rate for a personal loan is good if you’re consolidating credit card debt you had been paying 20% on. But that same 10% rate may be less appealing if you’re buying something discretionary, like a hot tub.

Read the loan’s terms. If your strategy to save money is to pay off the loan early, double check your loan documents before you commit. Fabian says you could face a prepayment penalty, similar to mortgage prepayment penalties, depending on the loan.

DIVE EVEN DEEPER

Personal Loan vs. Line of Credit: How to Choose

The difference between a line of credit and a loan is that a loan is borrowed as a lump sum, while a line of credit can be used and repaid on an ongoing basis.