How do personal loans work?

Personal loans are a relatively common financial need. If you’ve never borrowed one, it may seem a little complex. In this guide, we break down the features of personal loans, so you know what to expect when searching and applying for one.

How do personal loans work?

When you get a personal loan, you borrow money from a lender to pay for personal expenses. Over time, you repay the borrowed amount plus interest.

To take out a personal loan, you’ll need to complete an application form with your personal and financial information and provide documentation that proves your identity, income, residency and any other information your lender requires.

Types of personal loans

• Secured personal loan. This is a loan backed by collateral, such as your home, car or investments. It generally comes with a lower interest rate than an unsecured loan because your collateral reduces the lender’s risk of loss if you fail to repay the loan.
• Unsecured personal loan. This is a loan without collateral. It tends to come with a higher interest rate than a secured loan.

Types of personal loan interest rates

• Fixed rate. Get a fixed interest rate that will stay the same throughout the life of the loan.
• Variable rate. Get a variable interest rate that will go up, down or stay the same depending on how the Bank of Canada changes the prime rate. If the rate goes up, more of your payment will go towards interest and it may take longer to repay your loan. But if the rate goes down, less of your payment will go towards the interest and your loan will be repaid faster.

Personal loan rates in Canada

Learn more

How much can I borrow?

It depends on your financial situation. If you have excellent credit and a high income, you might qualify for higher loan amounts. If you have bad credit or a low income, you’ll likely be approved for less.

Are you willing to use your house as collateral? You secure a loan using home equity you’ve built up. Your home equity is the market value of your house minus the amount still owed on your mortgage. Likewise, if you use a paid-off car as collateral, your loan amount is affected by the value of the car.

What are the loan terms?

Your loan term is the amount of time you have to pay off a loan. Loan terms vary widely between lenders. You can generally pay off an unsecured personal loan in 3 - 60 months. A secured personal loan backed by home equity can come with much longer loan terms.

How do I repay a personal loan?

The lender will set up automatic withdrawals from your bank account. Payments can be weekly, bi-weekly, semi-monthly or monthly, usually falling around the time you get paid by your employer.

If your personal loan is not backed by collateral, you can repay it any time or make extra payments without penalty, which can cut down interest costs. If your personal loan is secured by a house, you’ll pay a prepayment penalty if you pay it off ahead of schedule.

How much does a personal loan cost?

The cost of a personal loan depends on the interest rate and any fees charged with the loan. The annual percentage rate (APR) reflects the total cost of a loan. Currently, lenders in Canada cannot charge more than 35%.

Related: Personal loan rates in Canada

Am I eligible for a personal loan?

These are the basic requirements for personal loans:

• You must be the age of majority in your province or territory (18 or 19 years old)
• You must have recurring income (full-time employment preferred)
• You must have a Canadian bank account
• You must have a minimum credit score (varies between lenders)

Do lenders consider your age?

A lender might land in hot water for denying a loan application based on age alone — which would be age discrimination. However, your life stage can often play a role in whether or not you get approved. Older, retired adults and younger individuals like 18-year-olds may have a harder time finding a loan.

At the end of the day, lenders are primarily interested in your ability to fully repay your debt. Lenders may approve or deny applications based on historical data showing that certain age groups are more or less likely to default on loans.

You can’t change your age, but you can show that you’re financially reliable, like maintaining a low debt-to-income ratio and a high credit score.

What’s the minimum income?

Minimum income for personal loans varies by lender. Some lenders require a minimum monthly income around $1,000 to $2,000, while others require a minimum annual income around $13,000 to $17,000. Others do not specify a minimum income because they approve applications on a case-by-case basis.

Some lenders don’t even require employment since they accept non-employment income such as government benefits or private pension. Income is just one of several factors that lenders look at when deciding whether to approve you for a personal loan.

How do I apply for a personal loan?

The application process for a personal loan differs among lenders. Many let you apply online, in person at a local branch or over the phone. Lenders will usually ask for the following information:

• Name and contact information
• Address and number of years at your current residence
• How much you want to borrow and the general purpose of the loan (debt consolidation, home renovations, emergency expenses, travel etc.)
• Employer, job title and income
• Existing debts
• Social Insurance Number (not always required)

Online applications usually take a few minutes to complete if you have all required information handy. Applying over the phone or at a branch takes a bit longer, but you’ll have someone present to help if you have any questions.

What documents do I need to provide?

Lenders that use instant bank verification to review applications do not need documents. Lenders that review applications the traditional (manual) way may ask for the following:

• Government ID. This can be a valid driver’s license, passport or other form of government-issued photo identification.
• Proof of income. You may need to provide three to six months of pay stubs or bank account statements. If you’re self-employed, lenders may request tax returns from the last three years.
• Other financial documents. Examples include proof of address, a list of your assets and liabilities, and a letter of employment.

Computer approvals

Sometimes your application might be declined by a “robot” without a human ever setting eyes on it. This is often more common with online lenders, because it helps speed up the application process.

Banks and lenders often use their own algorithms to check loan applications, automatically sorting the low-risk applications from the high-risk applications to preapprove strong applicants. This is one way to weed out prospective borrowers who don’t meet basic eligibility criteria.

If you’re considering applying with a lender that offers preapproval, review the eligibility requirements to avoid wasting time applying for a loan that you won’t get. Doing so can also protect your credit score from unnecessary hard pulls.

How long does a personal loan take?

This depends on the lender you go with. Below is a breakdown of typical turnaround times for the pre-approval, approval and funding stages.

Type of lender	Pre-approval	Approval	Funding	Total turnaround time
Online lender	A few minutes	30 minutes to 2 business days	24 hours	Around 1 to 3 business days	Compare personal loans
Peer-to-peer lender	Not applicable	A few minutes to 24 hours	A few business days	Around 1 to 2 weeks	Learn more about peer-to-peer loans
Bank or credit union	1 to 5 business days	A few business days to a few weeks	1 business day to a few business days	Around 1 to 4 weeks	Learn more about bank personal loans or credit union personal loans

What affects the turnaround time on a personal loan?

Aside from the type of lender you apply with, how long it takes to complete the personal loan process will depend on your:

• Preparedness. The more information you have readily available to you, the faster the application process typically takes.
• Source of income. Some lenders might take longer to process your application if you’re self-employed, since it can be more difficult to verify your income.
• Personal credit. Lenders might ask for more information or documents if your credit score is less-than-perfect or you have a short credit history.
• Collateral. If the personal loan involves collateral (a secured loan), the process will take longer whether you go with an online lender or bank because the lender needs time to evaluate the value of your assets.

5 tips to speed up the application process

1. Check the eligibility criteria. Applying for a personal loan you don’t qualify for means you’ll not only waste time, but you may also damage your credit score if lenders that you apply to do a hard credit check.
2. Gather your documents. Find out what documents your lender typically requires and gather them before starting the application.
3. Have your information on hand. Having the exact numbers on hand for your salary and monthly debt payments can cut down on the time it takes to fill out the application.
4. Ask questions. If you’re unsure of any part of the application, asking a customer service representative can ensure you don’t make mistakes that could slow down your application. Some lenders even have a live-chat feature.
5. Consider using a broker if you have bad credit. Borrowers with bad credit might have a harder time finding a personal loan they’re eligible for. Some online brokers like Loans Canada and LoanConnect can help you get pre-approved with multiple lenders even if you have a credit score under 560.

Related: Emergency loans in Canada

What should I watch out for with personal loans?

• Insurance. Some lenders try to add life or unemployment insurance to your loan. While insurance can be beneficial, these policies add to your total cost. Carefully consider the necessity of insurance before you agree.
• Pushiness. If a lender is pressuring you to get the loan, you may want to go elsewhere.
• Lack of clarity. Watch out for lenders who don’t explain loan terms to you.
• Guaranteed approval. If a lender is guaranteeing you’ll get approved for a loan, it could be a scam.
• Getting approved for more. If you apply for a certain amount but get approved for more, only borrow what you need. Extra funds may be tempting, but you’ll pay more interest overall.

Do lenders do credit checks?

Yes, a credit check is common when you apply for a personal loan. Some lenders, like banks and credit unions, only consider applicants with a good credit score over 660. If your credit score isn’t great, you can get a bad credit personal loan from alternative lenders.

There are also some lenders that offer no credit check loans, but these come with high interest rates.

Credit score vs credit history

What’s the difference between your credit score and credit history? These terms are not quite the same, and many lenders consider both.

If you’re looking for a loan, you should probably know your credit score. This is a three-digit number that lenders use to get a snapshot of your financial strength.

For a more in-depth look at your financial situation, lenders also consider your credit history. This is a detailed record of relevant credit transactions, including outstanding debts, recent inquiries, bankruptcies, loan defaults and more.

When should I avoid a personal loan?

Personal loans can be useful when you’re looking to consolidate debt or pay for a big expense upfront, but that doesn’t mean loans are always the best idea. Consider avoiding borrowing when:

• You’re making a large purchase. It’s better to save for some things. Weddings and large vacations can be costly, and many financial experts warn against borrowing money for something with no resale value. Find out how you can save with a high-interest savings account.
• You’re trying to rebuild your credit. While debt consolidation can minimize open accounts, this may not always be the best way to boost your credit score. Instead, make timely repayments and negotiate with creditors for lower interest rates instead of getting a new loan.
• You’re spending too much. It may seem obvious, but don’t overlook the effect of overspending. It’s best not to get a loan for discretionary or unnecessary purchases.

Bottom line

Personal loans can take a variety of forms and can be used for almost anything, but that doesn’t mean you should go with the first lender you find. Compare options before applying for a loan, so you can find the best terms and rates to cover your expense.

Dive deeper: Have time? Compare 40+ personal loans

Frequently asked questions

• Do I have to pay an application fee to apply for a loan?

  No. If the lender is asking you to pay a loan application fee, it may be a scam.

• Are there any hidden fees or charges for personal loans?

  There may be NSF fees, early repayment fees, administrative fees and origination fees. It's important to read and understand your loan contract before applying. If there is anything you don't understand, ask your lender for clarification.

• Can I pay off my loan in full or make extra payments?

  For unsecured loans, you can typically repay your loan early or make extra payments without incurring an early repayment fee. There may be a fee for paying off a secured loan ahead of schedule.