When you’re ready to plan that big wedding, buy a new set of wheels or consolidate debt you already have, a personal loan could help you cover the upfront cost. Understanding exactly how personal loans work is key to getting the best interest rate and repayment terms possible. This guide shows you how to compare top online lenders to narrow down your loan options. We take you through the process – including how to get the best interest rate that you’re eligible for.
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What is a personal loan?
A personal loan is money you borrow from a bank, online lender or credit union that you pay back with interest over a set period of time – usually between one to seven years. Your lender determines your loan amount, interest rate and fees based on factors like your credit score, income and debts you already have.
What can I use a personal loan for?
You can use a personal loan to cover almost any large expense or even to consolidate your debt. A loan can help you reach your next goal, whether it’s buying your dream car or boat, taking care of financial obligations like bills, or funding your next big purchase.
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Get access to a revolving amount of funds – similar to a credit card but with a higher limit and typically lower expenses. Great for funding continuous projects that might come with unexpected expenses. These can also be secured or unsecured. You are only charged for the money you borrow from a line of credit, which means you can have it open and not use it until necessary without being charged.
Personal loans can help you out when you have a big expense coming up but don’t have enough money on hand to cover the original cost. They’re generally better for larger one-time expenses, since they come in a lump sum and are usually not available in amounts less than $1,000. They also require some planning, since the application process takes some time – usually at least a couple of business days. Personal loans can be difficult to qualify for if you’re unemployed or don’t have a steady source of income – you’ll need to prove that you’re able to pay it off to get approved. You could also have a hard time getting approved if you have a history of making late payments or have never taken on debt before. You need a good to excellent credit history to get approved for the most competitive rates.
Can’t I just use my credit card?
You could, but it might cost a lot more if you need to cover a large one-time expense. That’s because credit cards often have higher rates than personal loans. However, if you need cash right away or only want to make a small purchase, using a credit card can be a better choice. That’s because personal loans can sometimes take weeks to be approved and disbursed.
I want a personal loan — where should I look?
Direct online lenders. These lenders offer straightforward application processes so you can conveniently borrow money online. If approved, your loan amount is deposited directly into your bank account. Compare direct lenders above.
Brokers. Brokers can pair you with a lender that suits your needs. After you fill out a preliminary application with the broker, you’ll be matched with a lender who offers the loan type you’re looking for in the amount you need. The lender must still make a decision on your application before you receive your funds. You won’t need to research lenders yourself if you choose this route.
Banks and credit unions. If familiarity is important to you, you can consider getting a loan through the credit union or bank you already have a relationship with. The application process may be expedited if you have an existing account with the institution. Keep in mind that banks and credit unions tend to have stricter eligibility criteria than other lenders, however, if you have a long history with them, this might work in your favour.
Peer-to-peer lenders. Relatively new to the financial market, peer-to-peer lenders operate as marketplaces that bring investors and borrowers together. They facilitate the loan process between individuals rather than offering the loans themselves. Your loan can be funded by one or many different investors.
Getting a personal loan from a bank
Getting a personal loan from a bank may seem like an obvious choice. If your bank offers loans, it might not be a bad idea to look into your borrowing options – they sometimes offer discounts to people that already have an account. However, bank loans typically have stricter eligibility requirements, have a longer turnover time and are sometimes even more expensive than other options.
Two main factors contribute to your loan’s cost: interest rates and fees.
Interest rate. This is what the lender charges you to borrow money and is usually a percentage of the loan amount.
Fees. There are a few fees that can add to the cost of your loan. It’s common to see administrative or processing fees of between 1-3% of the loan amount. Watch out for early repayment penalties if you plan to pay your loan off early. Lenders may also charge for late or missed payments and unsuccessful or failed payments.
Your annual percentage rate (APR) is an expression of your interest rate and fees together as a percentage. Your APR can give you an idea of how much your loan is going to cost you in total. APR doesn’t include late fees, insufficient funds fees or early repayment penalties.
Personal loan APRs typically range from 5% all the way up to 36%, which tends to be the maximum. Rates can sometimes go lower, but it’s uncommon. In fact, most people don’t get the lowest advertised rate on a personal loan, even if they have excellent credit. Here are some estimated interest rates that you might expect based on your credit score.
You might get an APR around…
800 – 900
720 – 799
650 – 719
600 – 649
300 – 599
Not likely to get approved
So, who gets the lowest interest rate? People with long and impeccable credit histories, high salaries and almost no debt. However, sometimes even those people can’t qualify for the lowest rates unless they apply to borrow over a certain limit.
How can personal loans affect my credit score?
Personal loans can either have a positive or negative affect on your credit score. If you make all of your repayments on time and according to schedule, taking out a personal loan can help you build your credit. In fact, some lenders offer small-dollar, short term loans with low interest rates that are specifically designed to help borrowers build credit.
Alternatively, personal loans can damage your credit if you fall behind on your repayments. Whether or not you’re able to make your repayments on time is one of the most heavily weighted factors a credit bureau considers when calculating your score.
5 tips for getting the best rate on a loan
If you have a long history with a bank or a credit union, you might want to consider borrowing from that financial institution to take advantage of already being a member. However, online lenders offer a wide variety of loan types that may fit your needs better than what your bank can offer.
You’ll generally need a score in the “good” range – 650 and above – to secure a decent rate. Your credit score and credit report are two different things. The latter is a detailed record of your credit history. Learn how to get a copy of your credit report and be sure to check for errors. Correcting errors, such as unpaid accounts that were actually paid, can help improve your credit score and help you get a better APR on a loan.
Loan applications may appear as inquiries on your credit report. Be sure to review the eligibility criteria to see if you qualify before applying for the loan. When comparing your options, you can also ask if the lender can give you a pre-approval before submitting your actual loan application. Asking questions before you fill out an application can help narrow down your options.
Having a lower debt-to-income ratio is sometimes just as important as having good credit: It can improve the rates and repayment terms you’re ultimately offered. Aim to keep your debt-to-income ratio under 20%.
The amount you apply for has a direct influence on the rate you’re offered, so only ask for as much as you need.
What makes a personal loan competitive?
There are a few key features you’ll want to consider when comparing personal loans. To find the best loan for your needs, ask yourself these questions:
Do I qualify for this loan? Don’t waste time researching a loan if you don’t meet the eligibility requirements. Applying for a loan that you’re not eligible for can negatively affect your credit score.
Can I borrow the amount I need? Will you be able to take out the exact amount you need and can you afford to pay it back in a reasonable amount of time? If not, you might want to look elsewhere.
Does it have a competitive interest rate? Look at the rate itself, but also consider whether it’s fixed or variable – variable interest rates are subject to change, while fixed are not.
What are the fees? Most lender will charge fees for an application, administration, early repayment and late or insufficient funds.
How long will I have to pay it back? Aim for a loan term that gives you monthly repayments you can afford without dragging the loan term out longer than necessary. Paying a loan off over a longer period of time will make it more expensive.
What lenders look for in a personal loan application
Lenders take on risk when they lend large amounts of money to borrowers. That’s why they require applicants to meet certain eligibility criteria. Here are some common qualifications lenders look for:
Good to excellent credit. Most lenders rely on credit scores when choosing borrowers to approve, and even calculate specific loan terms based on credit scores. If you have poor or no credit, a personal loan may not be for you since you likely won’t meet the minimum credit score criteria. If you have poor credit, check out our guide on bad credit loans to see your options.
Low debt-to-income ratio. You can calculate your debt-to-income ratio by dividing your monthly debt payments by your monthly income. Lenders can rely on this number as much as your credit score and normally don’t accept anyone with a ratio above 43%. A good ratio is anything below 36% although, as we mentioned before, under 20% is ideal.
Employment. Most lenders require you to be steadily employed. Some lenders have minimum income requirements as well that can include wages, investments, pensions or any other form of funds coming in on a regular basis.
Canadian citizen or a permanent resident. If you’re a Canadian citizen or a permanent resident, you’re able to apply for personal loans. Landed immigrants and temporary residents are only eligible to apply with certain lenders but may need to build up a credit history first. Having a valid Canadian address is also important.
18 or older. You should be at least 18 years of age or the age of majority in your province or territory.
Personal loan application checklist
The application process differs between lenders, but they’ll generally ask for the following:
Proof of your identity, like a government-issued ID or passport
Your Social Insurance Number and date of birth
Pay stubs, tax returns and other income details
Banking details for disbursing your funds and making automatic repayments
Utility bill in your name or other proof of residence
How to apply for a personal loan step by step
The first thing you need to do once you decide to apply for a loan is to determine exactly how much money you want to borrow. Borrowing too little or too much could leave you either unable to cover your costs or with extra money that increases how much you pay in interest.
There are quite a few loan types available, but beyond that, ask yourself what you’re looking for within your loan type. Do you want a secured or an unsecured loan? Do you want a fixed or a variable interest rate?
The first lender you come across may not have the best deal. Shop around and make sure to compare things like APR, fees, turnaround time and term of the loan. Be sure to read the eligibility requirements of each lender as well to make sure you qualify before submitting an application.
Applying for a personal loan is typically a quick and straightforward process that goes something like this:
Personal details. Gather the necessary information such as proof of identity (passport, driver’s licence or other valid government-issued ID), proof of address (utility bills or lease) and proof of income (pay stubs or bank statements).
Loan application. This is where you request a certain loan amount, specify what you want the loan for and choose your terms. Many banks and lenders have applications online, so you avoid the hassle of having to go to a branch and fill out paperwork. If you prefer to do it in person, head to a branch or a lender’s physical store location if they have them.
Loan agreement. If you’re approved, sign the loan documentation and agree to all of the terms.
Many lenders require that you have a working bank account to receive your money via direct deposit, but that’s not always the only option. Some lenders may be able to send you a cheque in the mail.
If you take out a loan for something specific, such as a new car purchase or debt consolidation, the lender may send the funds directly to the company you owe. If you take out a general personal loan, the funds will go to you to use for the purpose specified in your application.
It’s important to make your repayments on time so you don’t end up paying extra fees. Be sure to verify how you will be required to make repayments. Can you pay by phone with a credit card or account number? Is there an automatic payment option?
So you’ve been approved and the money is in your bank account. You’re done, right? Not quite. Now you have to pay it back.
Many lenders, especially online lenders, require you to set up automatic withdrawals from your bank account. Others might give a discount on interest if you set it up. Automated payment is a great way for you to make sure you don’t miss any repayments, but don’t think you can just forget about your loan. If your account doesn’t have enough money to cover your repayment, you could be slapped with an insufficient funds fee.
It’s a good idea to stay in touch with your lender, especially if you run into any trouble making repayments. Many lenders are willing to renegotiate your loan if you have an unexpected financial problem. You won’t know until you ask and you’d be surprised how willing many lenders are to help you out in your times of need. The fastest way to get in touch is usually by phone. Some lenders also have a live chat option, but those are generally better for finding basic information.
Most personal loans have interest that accumulates during your loan term, but some require you to pay most of your interest in the first few months. With the first type of loan, check if your lender charges early repayment fees. If not, you can save on interest by paying off your loan early. Paying off your loan early has other benefits: It can get you out of debt faster and improve your debt-to-income ratio.
5 easy ways to repay your loan back early
Make your monthly payment amount every two weeks. That is, twice a month. It’ll feel like you’re paying roughly the same amount but you can save on interest and shave a few months off of your loan term.
Round up your repayments. If making double payments is too much, rounding up your repayments to the nearest $50 is ideal, but even the nearest $20 could help you repay your loan months, or even years early.
Make one large payment during your loan term. Making one large payment toward your loan’s principle can help you save a lot on interest during the course of your loan.
Don’t skip payments. Not only will you likely have to pay a late fee, your interest will continue to accumulate at a faster rate.
Refinance. If your credit score has improved over the course of your loan term, or you experienced other positive changes in your financial situation, you might be able to qualify for another loan with more favourable terms, including a lower interest rate. With personal loan refinancing, you use the new loan to repay your original loan. Lower interest almost always means savings when the term length stays the same – or gets shorter.
Managing repayments with a debt consolidation loan
Already have a lot of loans? You may want to simplify your loans with a debt consolidation loan. This financial tool is designed to gather multiple debts into one place, often under one fixed rate. Look for a debt consolidation loan with a lower interest rate than what you’re already paying – that way you can also save on interest. How can debt consolidation help me save and manage my finances?
Growing a business with a small business loan
When you’re looking to expand your business, have seasonal sales or funding gaps while waiting for payments, a business loan can help strengthen your financial future. Business loans work a lot like personal loans but often come in a wider range of loan amounts and have different requirements to qualify. They’re usually tailored to specific business needs. Your business loan options include traditional term loans, lines of credit, invoice financing and more. You can secure a business loan with your personal or business assets.
Can’t qualify for a business loan? A personal loan could be a solution for entrepreneurs and startups looking for business funding. However, it might not be right for your business if your personal credit is the reason your business loan applications keep getting rejected.
Accrued interest. Interest that’s accumulated on a loan since it was issued but has not been paid yet.
Amortization. A loan that has regular, scheduled repayments that go toward paying both the loan’s interest and principal.
Annual percentage rate (APR). An expression of a loan’s interest rates and fees as a percentage.
Appreciation. An increase in an asset’s value (such as a car or home).
Asset. Anything that someone owns that has money value, including cash, a home, owed debt, a trademark or patent.
Autopay. A service that allows you or a loan provider to automatically withdraw money from your account on a regular (usually monthly) basis.
Borrower. The person taking out a loan from a bank, credit union or other lender.
Broker. A third party that acts as an intermediary between lenders and borrowers for a fee.
5 Cs of credit. An easy way to remember what lenders look at when determining your creditworthiness. The five Cs are: character, capacity, conditions, capital and collateral.
Capitalized interest. Interest that’s added to your loan’s principal instead of being treated separately.
Closing. Also, settlement. The final step in taking out a loan, when the loan agreement is signed and the funds are dispersed.
Cosigner. Someone who also signs your loans and holds responsibility to repay it if you default.
Compound interest. Interest that is periodically added to a loan based on your accumulated interest and principal.
Creditworthiness. How a lender values your likeliness to be able to repay a loan. Your credit score is typically used as the best expression of your creditworthiness, though your income, debts, age, employment status and other factors also play a large role.
D to O
Debt-to-income ratio. Your gross monthly income divided by your gross monthly debt payments.
Default. A failure to repay debts, which can result in the seizure of collateral or lawsuits.
Deferred payment. An arrangement in which a borrower doesn’t have to start making payments on a loan until a certain agreed-upon time (common with student loans).
Depreciation. A decrease in an asset’s value (such as a car or a home).
Down payment. An initial payment you make upfront when purchasing an expensive item. A loan is used to cover the rest of its cost.
Equity. The difference between the value of an asset (like a car or home) and the balance of a loan used to pay for that asset.
Escrow account. A third-party account that holds money before two parties go through with a transaction. Common with debt settlement companies.
Grace period. The amount of time a borrower has to make a payment before the lender charges a late fee.
Guaranteed loan. A loan where a third party agrees to assume at least part of the debt if the borrower defaults.
Interest. The amount a lender charges for letting someone borrow its assets, typically expressed as a percentage.
Loan agreement. The contract that a borrower signs agreeing to the lender’s terms and conditions.
Minimum and maximum loan amount. The largest and smallest amount of money a lender is willing to let someone borrow.
Negative amortization. When the loan payment doesn’t cover the accrued principal for that period, which is added to a loan balance.
P to Z
Prepayment. Paying more than your monthly payment on a loan, also known as early repayment fees.
Prime rate. The interest rate that lenders give to their most creditworthy customers.
Principal. Your loan balance, not including interest.
Promissory note. The document you sign before you take out a loan, legally binding you to the terms and conditions of repayment: your loan documents.
Purchase option. The option to buy a leased car or home, typically for a balloon payment.
Refinance. Taking out another loan with more favourable terms to pay off a debt.
Revolving debt. Open-ended access to a certain amount of funds that you pay off as your borrow, (like a credit card).
Secured loan. A loan that is backed by collateral.
Simple interest. Interest that’s calculated based on your loan’s balance, not balance and accumulated interest.
Strong credit. Having a long history of repaying debts on time with a high credit score – good credit or higher. Typically necessary to get approved for a loan with a competitive rate.
Subprime. Credit for borrowers with bad or poor credit, typically with higher interest rates.
Term. The amount of time a borrower has to repay a loan.
Title. A document that proves ownership of an asset (like a car or home).
Unsecured loan. A loan that is not backed by collateral.
Upside-down loan. When you owe more money on an asset that it’s actually worth.
Variable rate. An interest rate that is subject to change depending on the market.
Frequently asked questions about personal loans
No, a legitimate lender should not ask you to pay any funds upfront. In many provinces, it is actually illegal for a lender to request any money upfront. If a lender charges an origination or processing fee for a loan, they will typically deduct it from the loan amount. If a lender is asking for a prepaid card loaded with funds or for you to pay loan insurance, you should look elsewhere for a loan – it’s likely a scam. You should also be aware that loan insurance is never required.
You can typically borrow between $2,000 and $35,000. However, some lenders offer loans up to $100,000.
The best personal loan for you depends on how much you need to borrow, how quickly you need the funds and what you can qualify for. You may want to compare things like interest rates, loan amount and how legitimate the lender is.
Some lenders can approve your application by the next business day if you apply by a certain time. If additional verification is required or if you need to take documents to a branch location, this may delay the process a few days. You can usually find out the turnaround time from the lender before you apply.
The interest rate is what the lender charges for lending you the money. The APR is more representative of the true cost of the loan as it includes all fees that come with the loan as well as the interest rate.
You can, but it might not end well. Investing itself is incredibly risky and taking out a personal loan increases that risk even more. Some experienced investors take out personal loans after they’ve gotten the hang of weighing the risks, but it takes a while to get to their level, and even they don’t always win.
There’s no technical definition for this but prime borrowers are typically thought to have credit scores above 800, have no delinquencies on their credit report and have a minimum six-year credit history.
As with any personal finance decision, the ability to repay what you borrow is crucial. However, if you’re receiving government benefits, you may still qualify for a short term loan on welfare.
Interest rates vary by lender, but can be as low as under 3% and as much as 36%. Generally, the higher your credit score, the lower your interest rate on a personal loan.
Your interest rates will depend on lots of factors including your credit, the length of the loan and your other qualifications.
Personal loans themselves aren’t bad for your credit. As long as you make regular repayments and pay within the terms of the loan, a personal loan can actually improve your credit score to prove that you can handle your debt responsibly.
Unsecured loans are loans that don’t require any collateral. They are based on your creditworthiness. Keeping your credit rating at good or excellent will get you a better rate.
Most lenders offer loans from one to seven years, however some extend up to ten years.
The amount you can get for a personal loan depends on the type of loan and the lender. Typically you can borrow up to $100,000, however amounts usually sit around $35,000.
When you borrow money, you might end up with more than you actually need. Or, a last minute emergency expense might arise. Are you allowed to do whatever you want with the money as long as you repay it on time? This all depends on the type of loan you apply for. Some loans, such as home and student loans, come with restrictions and are virtually impossible to spend on something other than what they’re meant for. Auto lenders are typically more lenient but considering there will be a lien on your vehicle until the loan is repaid, it makes it more difficult to repurpose the funds. Some people will even take out loans without any plans of using the money the way they were intended to. In a process known as a “spread”, borrowers will invest money with the hopes of earning more than they have to pay in interest.
While there’s technically no law against it, if you default, your lender could still choose to take legal action should they find out that you’ve used the money for something other than what you agreed to. This would be on the grounds that you falsified information on your application.
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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