Buying a house is a huge financial decision. When you’re ready to get pre-approved, you might start to wonder whether you should look past a traditional mortgage to alternative home financing, like taking out a personal loan. While sorting through mortgages and personal loans may not be an enjoyable or easy task, it’s crucial when you want to buy a home and get the most favourable terms possible.
Mortgages are specialized lending for real estate. When you take out a mortgage, you’re taking out a secured loan that uses the property you’re buying as collateral. The most common type of mortgage in Canada is a fixed-rate mortgage amortized over 25- years – however you can amortize your mortgage anywhere from 5- to 35- years, depending on your situation. You’ll also come across variable rate mortgages, convertible mortgages and hybrid mortgages, but these types of mortgages are more complex and could lead to financial trouble if you’re not careful.
An alternative financing tool to purchase your home is a personal loan. You’ll generally need good or excellent credit for a personal loan, but you’ll find lenders that specialize in loans for those with less-than-perfect credit.
Personal loans are generally unsecured. This means you won’t have to put up any collateral. The result is that you pay more in interest and have a shorter term, generally less than 10 years. Personal loans aren’t usually intended to fund a home purchase, but that doesn’t mean you can’t do it. As long as your lender agrees to your loan purpose, you can use one for almost any legitimate reason.
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Main differences between personal loans and mortgages
Varies by lender, usually between 4% to 36%
Varies by lender, but can start as low as 2.5%.
Maximum loan amount
Up to $100,000, depending on the lender and your eligibility
Depends on income, credit score, value of home and other factors
Typically between 1 to 7 years
Typically 5- to 30- years, but can be up to 35- years
Usually monthly repayments
Usually monthly repayments, but can be weekly or bi-weekly too
What are the benefits of personal loans and mortgages?
No tax implications. You won’t be charged income tax on the amount you borrow.
No down payment needed. Unlike mortgages, many lenders don’t require you to provide any cash up front in order to qualify for a personal loan.
Negotiate repayments. You may be able to negotiate your repayments if you’re facing financial hardship or an emergency.
Secured. Since the loan is secured with your property, lenders are more likely to offer a much lower APR than an unsecured personal loan.
Pre-approval. You can get pre-approved and go house shopping with a clear picture of what you’ll be paying every month.
Tax advantages. Doing renovations or renting out an investment property can come with tax advantages and incentives.
What are the drawbacks of personal loans and mortgages?
Short repayment terms. Most lenders have repayment terms lasting one to seven years.
Interest rates. Since you’re not providing collateral, you’ll likely have a higher interest rate and will need to pay more in interest over the life of your loan.
Small loan amounts. You’ll only be able to borrow up to $50,000 or $100,000 if you have impeccable credit. Otherwise, your funding will be limited to $35,000 or less.
Foreclosure. If you fail to make repayments and default on your mortgage, you could lose your home in foreclosure.
Amount paid. Despite low interest rates, mortgage loan amounts tend to be very large and have long repayment periods of up to 35- years. This means that by the end of your repayment period, you’ll likely have paid tens of thousands of dollars in interest alone.
Payment fluctuations. With a variable rate mortgage, the payments you make can fluctuate drastically with the market.
Which borrowing option is better suited for me?
The better option will depend on your needs as a borrower. Mortgages are by far the most common option because they’re meant for real estate. Fixed-rates make for an easy repayment plan, even if it doesn’t have as attractive an initial interest rate as a variable rate mortgage. If rates drop significantly, you can take steps to refinance a fixed-rate mortgage to a variable rate, which could potentially lower your monthly payment if the prime rate stays low.
In addition, buying a home outright on $100,000 or less is nearly impossible in most parts of Canada these days. Some lenders will allow you to use a personal loan as a down payment, but otherwise, you’ll have a hard time covering the costs of a purchase. However, if you’re looking to fill that new home with some furniture, a personal loan is an option to consider. Personal loans can be used for many purposes, which make them useful when it comes to home improvements or other big purchases.
What’s the difference between a personal loan and remortgaging?
You might have come across the term remortgaging in your research. Remortgaging is another term for refinancing. When you remortgage or refinance your mortgage, you pay off your current mortgage with a second mortgage through a new lender, usually one offering a lower interest rate or better terms.
While refinancing can sound complicated, it’s common practice for people who have improved their credit over time or live in areas of high real estate fluctuation. If your home’s value has increased or you’ve simply found a lender offering a better deal than your current lender, you may be able to save thousands of dollars in interest over the life of your mortgage, while reducing your monthly payments.
The refinancing or remortgaging process is more similar to taking out a mortgage than borrowing money with a personal loan. If you’re happy with your current mortgage but need a loan for home improvements or other big expenses, you might want to consider a home equity loan or line of credit instead. These options are like personal loans, except you typically only have to pay the interest each month instead of paying extra toward the principal balance. A home equity loan or line of credit is also secured against your house, meaning the interest rates can be lower than that of a personal loans.
When choosing between remortgaging and a personal loan, the better option depends entirely on what you need the loan to do. Remortgaging is ideal for specific goals — like lowering the monthly payments on your house or switching from a variable rate to a fixed-rate mortgage — while a personal loan is designed to cover costly purchases without restrictions. Approval for both usually depends on your credit score and your history of timely payments.
Personal loans can be good for a wide variety of things, but they’re not necessarily the best for funding the purchase of a home. Mortgages are exclusively used for purchasing real estate and can generally offer you much better terms and a lower interest rate. Before you make any big financial commitments, you should talk with a financial adviser and compare your options. Whichever you choose, have your finances in order and understand the full impact of each type of loan when you apply.
The minimum down payment required on a home in Canada depends on the value of the house.
If the purchase price of your home is less than $500,000, the minimum down payment is 5%.
If the purchase price of your home is between $500,000 to $999,999, the minimum down payment is 5% of the first $500,000, and 10% of any amount over $500,000.
If the purchase price is $1,000,000 or more, the minimum down payment is 20%.
Good credit definitely helps. It is possible to get a mortgage with a low credit score, but you’ll likely face higher interest rates. It may be worth taking steps to raise your credit score before you get a mortgage.
While specific documentation will vary by lender, you’ll typically need to provide two forms of government-issued ID, verification of your last two years of income, bank statements and proof that you have the funds for closing costs.
In many instances, you can get a personal loan to pay off your mortgage. Keep in mind that many mortgages come with lower interest rates than personal loans. Be sure to evaluate the APR and the final cost of both loans before making a decision to pay off your mortgage with a personal loan.
Aliyyah Camp is a writer and personal finance blogger who helps readers compare personal, student, car and business loans. Aliyyah earned a BA in communication from the University of Pennsylvania and is based in New York, where she enjoys movies and running outdoors.
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