The following excerpt is from Chapter 9 and 10 of Vesna Milevska's book Financial Hacks.
Chapter 9: Loans
Getting a loan from a bank may be a good alternative when you need to borrow money for the short term (5-10 years) with a fixed interest rate and fixed monthly payments. Loans are typically for five years and interest rates vary. The most popular loans are debt consolidation loans, student loans, car loans, RRSP loans, and business loans.
If you find you cannot afford your monthly payments on your credit cards and are only able to make the minimum payments, consolidate your debt. This will allow you to get a lower interest rate and allow you to pay off the debt in about five years.
Do not forget to negotiate your loan rate! If you ask for a 0.5% lower rate, you just may get it.
Note that when you consolidate debts, there is a high probability that you will need to close some of your credit cards.
RRSP loans are very popular during the winter RRSP season. They are usually set up with lower interest rate than regular loans. At present, the rates are about 5%. With the money you borrow, you will make a contribution towards your retirement savings. A few months later, you will receive a tax refund (remember, the amount of the contribution is not taxed in the year in which the income was earned). You can use the refund to pay off the interest and part of the capital that you borrowed. Your contribution will stay in the RRSP, working for you tax-free, until such time as you withdraw the money. The loan itself can be repaid from your monthly income.
RRSP loans typically have to be repaid within one year. They are usually not restricted in terms of being paid off earlier than the original term with no penalties. Ask the bank!
An alternative when you get your tax refund is to pay off any outstanding balances on your credit cards. That way you will have switched your debt from a high interest vehicle (the credit card at 20%) to a lower interest one (the RRSP loan at 5%).
Auto loans are generally more expensive with the banks (7% to 9% at present) than with the car dealerships. First, ask your dealership about the interest rate and term (amortization period). Then, compare what your bank can offer.
Business loans are another type of loan and you can use this credit if you have a small business. They are cheaper (8% to 11% at present) than credit cards (remember that 20%), but not personal loans (as low as 3% to 5% if you have a good credit rating) and the interest you are paying is tax deductible. Interest on personal loans is not tax deductible unless the borrowed money is used to make an investment on which you expect to make profits, such as buying stocks or mutual funds.
Borrowing money to invest (except RRSP loans) is very common with investors. All the interest paid on the loan is tax deductible. If you can borrow money from a bank to make investments, you can access markets at any time, even if you do not have cash of your own available. Of course, this is a big problem if the stock market never makes money for you. If you do borrow for investment purposes, you should have monthly payments you are comfortable with and make sure you declare the interest on your tax return.
A very interesting and popular type of borrowing for large investments is a loan against the equity in your house. I will talk in the detail about this in chapter ten (Line of Credit).
Tips on Loans
Always ask if you can make a lump sum payment on your loan without penalties. Apply every bit of extra money towards the loan principle. You will pay your loan faster and you can start saving for big financial goals.
Loan applications are approved based on your annual income qualification and credit rating.
Negotiate the interest rate you have to pay. Be reasonable in your demands and prepared to go to a different bank if you can't get the rate you want. No bank will lend you money at less than the prime rate. 17 Many will try to charge you prime plus 2%. You may be able to settle on prime or prime plus 0.5%.
Experiences with Loans
I have a friend who had $45,000 worth of debt on different credit cards. She was making minimum payments every month, which was half of her monthly paycheque. It became unbearable for her and she was considering bankruptcy. After we reviewed her statements I convinced her to consolidate her debt with a five-year loan.
Her monthly payments on the loan were cut in half. The best part was that the bank that provided the loan closed all but one of her credit cards and it had the lowest interest rate. She paid her loan off earlier than expected and she started depositing the same loan payments she was used to into a savings account. Seeing her savings grow every month encouraged her to save even more and in two years she had enough money for a down payment on her first home. Her credit rating improved dramatically. It is never too late to turn your life around!
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