Rounding it up
There are many kinds of loans in Canada, from mortgages and car loans to personal loans and home equity loans.
Loans in Canada are either secured or unsecured and they can be either open or closed.
Each type of loan in Canada has its own approval requirements and costs.
Your credit report and score play a huge part in the type of credit you can get and the interest rate that you’ll be charged.
Let’s face it. You can’t pay for everything you want all upfront. Sure, you might be able to pay for a used car with cash but you won’t be able to buy anything else for quite some time and your finances will surely suffer.
That’s where credit and loans come into the picture.
Loans help Canadians make purchases that they wouldn’t normally be able to afford upfront. Plus, there are loans out there for just about anything you may ever want to buy in Canada.
From auto loans to mortgages and personal loans to credit cards, Canadians are able to use the power of credit to pay for many different kinds of purchases over time. Let’s take a quick look at some of the main types of loans in Canada and some of the loan products that are best avoided.
Credit Reports and Scores
Your ability to make purchases using credit is reliant on your credit score and report. A credit report is a record of all the dealings you’ve had with lenders and loans over the years. It helps companies determine whether they’ll extend you credit and, if they do, what your interest rate will be. Interest rates are simply a calculation of risk—the worse your credit score, the higher your risk and the higher your interest rate will likely be.
Lenders report your payment activity in Canada to the two major credit bureaus: Equifax and Transunion. Your score is then calculated as a numerical representation of what appears on your report.
Financial institutions will also judge your score slightly differently to ensure they’re getting the types of customers that they want. It’s important to note that different types of loans will also have their own unique report and score requirements. For example, the credit score required to get a personal loan will be slightly different than one required to get a mortgage.
So What Types of Loans Are There in Canada?
In short, there are many different types of loans in Canada.
There are loans for nearly every conceivable type of purchase from cars to products and services. But there are generally two categories of loans we’ll be looking at: closed and open.
A closed loan is one that finances a specific product like a home or car. The line of credit that you get with these loans is only enough to cover the cost of the actual item (i.e., a car or home). When you’ve finished paying off the loan, you own the item and the credit line is closed.
The second type is called open-ended credit. These include credit cards and home equity lines of credit, which let you continually borrow money to make all sorts of purchases.
There are also two other common categories of loan products out there: secured and unsecured loans.
Secured loans are backed by a specific item, called collateral. Your car loan, for example, is secured because if you fail to pay, your lender will repossess the car. Your credit card, however, is unsecured because there is no item backing your credit.
The credit requirements for closed and open or secured and unsecured loans will depend quite a bit on the lender, the loan product in question, and your credit score.
With that in mind, here are a few of the most common types of loans that you’ll encounter in Canada.
Mortgage loans are some of the most common lending products available in Canada. The size of the average mortgage has ballooned more than 50% over the course of the last few years as homeownership has become a goal for many Canadians.
When you’re house shopping, it’s important that you look around for different mortgage rates to ensure that you’re getting the best possible deal. You can often pre-qualify for mortgages with many lenders depending on your credit report, score, income and other factors.
Also, keep in mind that mortgages are secured, closed-end loans, so you can lose your home if you fail to repay your debt.
Be sure to take into account repairs you may need to make to your new home and the cost of both homeowner’s insurance and local property taxes before you decide to purchase a house. Plus, most Canadian mortgages are reevaluated every five years, so you’ll want to plan ahead for future changes in your interest rate.
Home Equity Loans
Home equity loans give you the ability to borrow money against the amount of equity you’ve built up in your home. Most people who use home equity loans will do so to finance larger improvements to their houses.
How these loans work is fairly straightforward. Imagine you have a $500,000 mortgage and you’ve paid off $100,000 of that loan to date. As such, you’d have at least $100,000 of equity in your home (or possibly more if your property value has increased).
A home equity loan servicer could provide you with a line of credit based on a percentage of your current equity. Most lenders won’t give you more than 85% of the equity you have in your home as part of one of these loans, but the amount you can borrow will vary from bank to bank.
It’s important to understand that, with these loans, you’re using your home as collateral. So if you default on your debt, the bank can force you to sell your home to recoup their cost.
Home equity loans can be open or closed. An open home equity loan is often called a home equity line of credit and it allows you to use your equity almost like a credit card. But most home equity loans are considered closed after you pay off your debt.
Vehicle loans are secured, closed-end loans that help you finance the cost of a new or used car.
Interest rates on these loans can vary widely based on the value of the car, the length of the loan, and your creditworthiness. New cars tend to have lower rates than older cars because they are more valuable.
You can typically get auto financing from your own bank or credit union, or you can work with a dealer to secure financing. Either way, be sure to shop around for the best rate and lending terms before you sign up for an auto loan in Canada.
Credit cards are a type of open-ended line of credit, and they can be either secured or unsecured. In Canada, credit cards are incredibly common. In fact, Canadians use them to pay for all sorts of things, from groceries to vacations.
Most credit cards are unsecured, but some models that are designed for people with low credit scores are secured. With secured cards, you’ll need to provide a down payment of a few hundred dollars to serve as collateral against your spending. Unsecured credit cards have no such down payment requirement.
Interest rates on credit cards are typically between 15% and 25% or more, so failing to pay off your entire statement balance each month can get extremely expensive. Carrying a $1,000 balance with an 18% interest rate and making a minimum payment of only $35 dollars each month will cost you more than $300 in interest and take you just over three years to pay off. Not good.
Personal loans are closed-end, unsecured lines of credit that are used for a variety of different purposes. Whether it’s construction on your home or funding a vacation, personal loans can normally be used to finance your purchases (but double-check any spending restrictions from your lender before you apply).
You’ll generally have to have fairly good credit to secure a personal loan since they’re almost always unsecured. Interest rates can also be very high on personal loans, especially if you don’t have great credit.
Therefore, if you’re considering a personal loan, you should always strongly consider whether you actually need to borrow money for your purchase. If you need the money for something important, such as home repairs, and you can afford to pay back the loan, it may be a worthwhile option. But if you’re making $60,000 a year, it may not be smart to borrow $10,000 to go on a tropical vacation.
Going to university isn’t cheap, especially if you attend a big-name school or you’re training to be a doctor or lawyer.
Thankfully, the federal government has a variety of aid options to help students and you can sometimes get financial support from your provincial or territorial government, too. But if you’ve exhausted all your government-sponsored aid, you can also check out student loans to help offset the cost of your studies.
Keep in mind that you will need to repay these loans after you graduate. You may also need a cosigner for your student loans. Always read the fine print and ensure you understand your repayment requirements before taking out a student loan.
Payday and Cash Advances
Payday and cash advance loans actually have nothing to do with your credit score. In fact, these lenders generally don’t check your ability to repay the loan because the value of your loan is securitized by your upcoming paycheque.
These loans are typically short-term and, to put it plainly, extremely expensive. Many people view payday loans and cash advances to be predatory financial products.
In Canada, payday loans can have interest rates of over 500%, so you’ll quickly find yourself owing way more than you originally borrowed when you use these products. There may also be hidden fees and additional charges that make these loans even more expensive.
Ultimately, payday and cash advance loans are designed only to cover brief cash shortfalls and they’re typically best avoided. If you’re using them to cover regular expenses like rent or groceries, you can work yourself into financial trouble very quickly.
Buy Now, Pay Later
One of the newest types of loans in Canada isn’t marketed as a loan at all (though it basically is). Rather, they’re called Buy Now, Pay Later services, and you can find them at many online retailers.
The principle behind these services is simple: You’ll make your purchase without paying anything upfront. Then, you’ll be responsible for paying off your purchase over time (normally in 4 to 5 installments). Most of these loans have no interest if you pay them back on time but they may charge late payment and other similar fees.
While there isn’t typically an interest rate associated with this kind of loan product, you will likely still have your credit checked when you sign up for this kind of service. So, always consider if Buy Now, Pay Later is truly worth it for your purchase and if you can actually afford the product you’re trying to buy before you sign up.
Loans Can Be Powerful Tools—If You Use Them Properly
There are as many different types of loan instruments in Canada as there are products to finance with them, for example, Loans Canada is comparison platform that will help you find the best rate. If you opt to take out a loan, be sure to do your homework to ensure that you know what you’re signing up for. Always double-check any fine print and hidden fees, and never borrow more than you can afford to repay.
Dan is a runner and writer living in the Washington, D.C. area, where he currently works for a financial services trade association as the Communications Director.