If you're like most Canadians, you shop around a lot before choosing a car or house. Fewer people put the same energy into choosing a loan. Maybe they feel lucky just to get the money. However, if you take this approach to borrowing, you may pay more than you need to.
When you shop around, you can:
- Compare interest rates and other costs.
- Learn about the different options available to you.
- Avoid rushing into a bad decision.
Example: Let's say that you have $5,000 saved to buy a used car, and you need $2,000 more. You consider using your credit card, which charges 18% interest. You also look into getting a loan at your financial institution. They offer you a two-year term loan at 7%. Here's how much interest you would pay with each choice:
Credit card: $396.40
In other words, it would cost you more than twice as much to borrow with your credit card.
Six questions every smart borrower asks
- How much do I have to pay each month? Make sure you can afford the monthly payment. How much is too much for your budget? The experts say if you have a mortgage, your debts, including your mortgage, should add up to no more than 35% to 40% of your monthly income (before taxes). If you rent, your debts should not add up to more than 15% to 20% of your monthly income.
- What is the total amount I will repay? This is how much the loan will cost when you add up all the interest you will pay, as well as all of the money you borrowed. The rate varies according to the type of loan. Some interest rates are fixed for the whole term of the loan. Others may go up and down as the Bank of Canada rate changes. Make sure you know how the interest on your loan works before you sign.
- Is the loan secured? The interest rate on a secured loan will often be 1% or 2% lower than an unsecured loan. Just keep in mind that if you don't pay, you are giving the lender a legal claim to whatever you use to secure the loan. That might be your home, your car, or other property.
- How long will it take to repay the loan? This is the loan term. The longer the term of your loan, the more interest you will pay (if the interest rate stays the same). Find out if there is a penalty fee for paying the loan off early. More and more lenders are charging a fee if you make extra payments, or repay the whole loan off early. That's because they will earn less interest from your loan.
- If I miss a payment, does the interest rate change? Sometimes the interest rate increases by 2%, or more, if you do not make a payment by the due date.
- Do I have to pay for any insurance? Sometimes you have the choice of insuring your loan. This means the lender will make your monthly payments if you can't for specific reasons; for example, if you get sick and can't work. If you insure the loan, find out how much extra it will cost. Sometimes you may decide you don't need the insurance.
Remember: It pays to ask questions when considering a loan
Some loans cost quite a bit more than others. It's always worth exploring all your options. Before you sign any contract, make sure you understand the advantages and drawbacks of each choice.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.