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In the event of a financial emergency, Canadians tend to rely on their savings and credit products such as personal loans, credit cards, and lines of credit for financial support. However, Canadians use credit for more than just emergencies, they also use it to build credit and finance items that are too expensive to pay for upfront, like a car or house. Given the necessity of credit, it's important to understand the do's and don't of borrowing.
Before applying for a loan, it is wise to understand where you stand as a borrower. Checking your credit score can help you strategize which lenders you should apply with and what you can do to strengthen your approval. For example, if your credit history is less than great, you can choose to wait and build your credit before applying or you can apply with lenders that accept borrowers with bad credit. Doing so will prevent you from unnecessary credit inquiries that negatively impact your credit.
Using loan comparison websites to get quotes from multiple lenders prior to applying is a resourceful and efficient way of securing the best rate. Loan comparison websites allow you to compare rates, terms, and reviews with minimal effort. Moreover, you’re able to receive multiple quotes from different lenders with a single application. Overall, you’ll be able to make an informed decision that will positively impact your finances.
Before signing the agreement, be sure to review all the factors that can affect the cost of your loan. Doing so will prevent any surprise fees from being added to your debt. Here are the main factors to review before signing the contract:
What interest rate are you being charged? Is it affordable? If the interest is too high, consider improving your finances and credit to get a better rate.
Borrowers are often surprised with fees they didn’t read about in the contract.
- Late fees - In the event, you miss a payment, how much of a late fee will you be charged? If the fees are exorbitant, it may be wiser to consider a different lender.
- NSF fees - Lenders typically receive their payments via direct debit. If you fail to make a payment due to insufficient funds, you’ll not only be charged a late fee, but an NSF fee charged by your lender and potentially your bank as well. These charges typically range between $25 - $45.
- Prepayment fees - If you plan on paying off your loan early, you should review the fees on prepayments. Lenders typically want you to complete the term as they earn more interest that way. To curb such behaviour, they often charge high fees for prepayments.
- Term length - Be sure that your term works with your budget and isn’t just a term that provides you with the lowest payments as this will cost you more in the long run. A shorter-term means higher payments but ultimately the total cost of your loan will be lower.
Your credit score consists of five factors: payment history, credit utilization, length of credit history, credit mix, and credit inquiries. Of these, your payment history accounts for a little more than one third (35%) of your credit score. As such, missed or late payments will have a significant impact on your credit score, which in turn will affect your future ability to access credit. Moreover, you’ll be subject to late penalty fees. Automating your payments or arranging automatic withdrawals will help prevent late payments.
If you’re having trouble managing your debt, it’s important to reach out for professional help before things get out of control. A financial advisor can help you reevaluate your budget to include your debt payments. They can also help develop a plan to repay your debts faster. A credit counsellor can also help by providing debt relief solutions such as a debt management program, where they can renegotiate the interest and monthly payments with your creditors.
If you know you won’t be able to make a payment, it’s wise to call and inform your lender. Lenders are usually willing to help and work with you as they prefer you paid later on, rather than completely defaulting on your loan. Depending on your lender they may offer you temporary relief through a payment deferral, interest-only payments, or a new payment plan.
As previously mentioned, credit scores are made up of five factors: payment history, credit utilization, length of credit history, credit mix, and credit inquiries. Of those, your payment history carries the most weight at 35%. As a result, missed and late payments will negatively affect your credit score. Late or missed payments are typically reported to the credit bureaus approximately 30 days after the due date. Once reported, you’ll have a note about the missed payment in your credit report for up to seven years. You should also try your best to avoid late and missed payments as it often results in late payment fees and sometimes a hike in interest (usually for credit cards).
When taking out a loan, be sure to borrow only what you need. While it may be tempting to take out the maximum amount, you shouldn’t, as what you qualify for isn’t always what you can afford. Budgeting and preparing for unexpected expenses or an unfortunate life event like a job loss are critical to managing your debt.
In general, it is recommended that you borrow no more than 43% (ideally 36%) of your gross income, with 28% going towards rent or a mortgage. To calculate your debt-to-income ratio simply add all your monthly debts and divide it by your gross monthly income.
In general, when you apply for a new credit product, you’ll be subject to a hard inquiry which will result in your credit score decreasing by several points. If you apply for a car loan, a credit card, and a personal loan all within a short period of time you will undergo multiple hard inquiries. This can cause your score to decrease by a more significant amount.
However, there are exceptions to the rule. If you’re applying for a personal loan, multiple hard inquiries for the same type of credit product within a short period (14 - 45 days) will be counted as one inquiry.
Payday loans are the most expensive way to borrow money. They have a short term of 14 days, and an APR that averages around 500%. Moreover, payday lenders often charge exorbitant fees for late payments. As a result, many Canadians fall into the payday loan cycle, a cycle of debt that can easily ruin your finances.
In general, it’s recommended you use a payday loan as a last resort. These short-term, high-interest credit products are typically relied on by individuals who were credit constrained. In fact, according to a report by the Financial Consumer Agency Of Canada, 60% of Canadians who have used a payday loan did not have access to a credit card.
Depending on your borrowing needs, some credit options will work better than others. For example, if you plan on purchasing a car, a car loan will usually provide you with better terms and a lower rate than a personal loan due to the security it provides. It is also important to understand and prepare all the necessary documentation you need when applying for a loan. That is to say, incorrect information and lack of documentation can lead to your loan application being rejected.
There are many benefits and drawbacks when it comes to borrowing. While it can provide you with the means necessary to afford certain products and services, it can also overwhelm you with unmanageable amounts of debt. As such, before you take on any debt, be sure to budget and refrain from borrowing more than you can afford.