LOANS

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What is it Used for?

A loan (sometimes referred to as 'credit') is borrowed money.

When you take out a loan, you get money - called "principal".
You'll have to pay it back and, usually, it won't be free.

Most loans / lenders have you repay the principal (what you borrowed) in small regular payments.

You can can borrow money from most financial institutions (like banks, credit unions, and independent loan providers) by signing a loan contract.

You can also borrow money from friends and family.

Key Features Tip

Before you take out a loan, google a loan calculator and calculate in dollars the cost of your debt. For example, if you borrow $3,000 for 1 year at 7% interest, you will pay $115 to the bank. Would you rather delay your purchase until you save $3000 and keep the $115, or do you prefer to make the $3000 purchase now and pay $115?

Key Features

Interest Rate

This is the cost of borrowing money.

It is measured as a yearly percentage of the loan's outstanding principal (what you have not yet repaid) - the more you've repaid, the less you’ll pay in interest.
You'll pay interest regularly to your lender until you've repaid the entire principal.
The higher a loan's interest rate, the more it'll cost you.
Interest can stay the same until you repay the loan (called a "fixed" rate) or it can change over time (called a 'floating' or 'variable' rate).

Term of the loan
This is the amount of time, usually in years, over which you agreed to pay back the entire principal.

The longer you take to pay your principal, the more interest payments you'll make, and the more expensive your loan becomes in the long run.
The advantage of taking longer is that your principal payments will be smaller and more manageable. This is especially important if you have a tight budget and cannot afford to make large payments.

Payment Terms

For most loans, you'll have to start making interest / principal payments immediately.

Some loans let you briefly defer payments (student loans, for example, don't require any payments until you graduate).
Some loans allow early principal payments, called pre-payments.
Some let you 'skip' one payment per year without penalty. It's just a payment deferral - you still owe the skipped payment.

You and your lender will agree on how often you'll make interest / principal payments.

Principal is usually repaid partially, in regular chunks.
Payment frequency can be weekly, bi-weekly, semi-monthly, or monthly.

The more often you make principal payments, the faster you'll pay back your debt and the less you'll pay in interest overall.

Borrowing Money is a Decision:

You buy something now and borrow cash to pay for it - you’ll owe interest which means that the price of what you buy is actually higher
You wait with the purchase until you’ve saved money to pay the price. As you keep saving, you earn some interest, which should make up for inflation (inflation means an increase in prices)

When it’s rational to borrow

When the cost of borrowing justifies it. For example:

For education - if the degree or new skills lead to a better job or career
To advance in your profession - buying essential tools for your job.
To lease / buy a car.
To buy a home / condominium.
To cover a temporary shortfall or emergency - you may have irregular income / are going through a rough patch.

Irrational debt

When it’s super easy to get the loan and the high interest makes it difficult to pay the debt back.

Credit cards are a useful payment method. But when used as a loan, they are very expensive. And they are easy to pay for things without thinking if you can afford the purchase.

Payday loans rarely solve people’s financial problems. In fact, they make them bigger because they are extremely expensive.

What Kinds of Loans are There?

Student debt:

There are government loans and bank student loans. With government loans, you start paying interest and repay the amount you borrowed after you graduated. It’s not likely that the amount you can borrow will cover all your tuition and cost of living. Bank loans are available only for certain professional and graduate programs - you pay interest as soon as you borrow, and start repaying what you borrowed after graduation.

Line of credit:

If you don't know exactly how much you need, or when you need it / when you'll repay it, a line of credit may suit your needs. A line of credit has a maximum limit you can borrow, just like your credit card. Unlike credit cards, lines of credit have no monthly grace period on interest payments - you'll start owing interest as soon as you draw on your line. You can start repaying the principal (what you've drawn) when you’re ready.

Personal (term) loan and installment loan:

If you need cash to purchase a specific item, a bank term loan or vendor financing may be available. You will repay the loan along with interest over a certain period of time by making regular payments.

Car loan and lease:

When you take out a loan to buy a car, you’ll borrow enough to pay for its entire value. After you pay off the loan, you own the car (if you buy it for cash, you own it immediately). When you lease a car, you pay for the portion of its value that you "consume" during the term of the lease. You get to use the car during the term of the lease but won't own it at the end of term. You have the option to buy it at that point by making an additional payment).There are certain conditions on how you can use the car during the term of the lease (maximum mileage and wear-and-tear). In both cases you can make a downpayment using cash you’ve saved - this means you borrow less and pay less in interest on the lease or loan.

Mortgage loan:

When you decide to buy a house or condo, you will be your own landlord. You’ll need to have enough money to purchase the place and cover all ongoing costs related to ownership. Most people have enough savings to make a downpayment but not to pay the full price, and need to borrow the rest. This type of loan is called a mortgage. A mortgage is repaid in equal monthly payments that cover interest due and a portion of the principal of the loan. It can take 30 years to pay back one’s mortgage - at that point you own the house.

Not a loan:

When you rent you are a tenant and pay the landlord (the person or company who owns the place) an agreed upon amount each month.Details of your agreement with the landlord are in a document called 'lease'. You can download a standard residential lease agreement for your province. Your rights as tenant are protected by relevant legislation. It’s rational to rent rather than buy as long as you are diligent about saving money every month and investing it. Because when you rent, after 30 years you will not own the condo or house. But you will have your investments.