What is a Personal Loan?

A personal loan is when you borrow a fixed amount for personal needs (as opposed to for business needs) from a lender and agree to paying it back by instalments over a specified timeline. Personal loans usually have specific reasons like paying for a large expense, doing home renovations, consolidating debt and much more.

Personal loans can vary in size and terms. Unsecured personal loans are typically between $500 and $10,000. They can be much larger in size, going up to $30,000 and more, especially if the loan is secured, such as a home equity loan.

How Does a Personal Loan Work?

Personal loans work a lot like other loan types. You’re borrowing money from a lender that you eventually have to repay with interest and fees, as applicable.

There are many lenders to choose from for personal loans in Canada. Some factors to consider when choosing the right loan and provider for you are: loan amount, term length, fees, interest rates and repayment structure.

Personal Loan Example with Numbers

To get a better understanding, let’s run through a personal loan example with some numbers.

How to Qualify for and Obtain a Personal Loan?

Lenders consider several factors before they’ll approve you for a person loan. It’s helpful to know the qualification criteria before applying to ensure your loan application is a good fit for the lender since each loan application counts towards your credit score, even if it’s declined. Requirements for a personal loan typically include steady income from employment, being a Canadian citizen or permanent resident, being over the age of majority and having at least a fair credit history and rating. Individuals that are in collections from previous loans or are under an undischarged bankruptcy or consumer proposal will have a more difficult time getting approved for a personal loan.  

Debt

If you have any debt (mortgage, line of credit, student loan, car loan, etc.), it must be factored into the loan application. That’s because the lender will want to know how much of your monthly income is already going towards servicing other debt. If you have too much debt, your loan amount could be reduced or worse, your loan application could be denied.

Financial Commitments

Are you paying alimony/spousal support or child support? This must be factored into your personal loan application. If you’re in receipt of these, it may help you qualify for a higher loan amount if it’s counted as income.

Credit

All things considered equal, the better your credit score, the easier it will be to qualify for a personal loan. Lenders look at your credit history and credit score to deem whether you’re a creditworthy borrower. If you have poor credit, you may be required to pay higher rates or your application could be turned down.

Income

The higher your income, the easier it is to qualify for a loan. If you can’t qualify for a loan on your own, you might consider adding a cosigner or guarantor to the loan application.

Employment Status

Someone who’s a salaried employee will typically have an easier time being approved for a personal loan than someone who is on contract or self-employed.

Assets

If you own any valuable assets, there’s nothing stopping you from using them as security to help get an even lower interest rate on your personal loan.

Key Benefits

The repayment amount and terms helps you stay on track. You’ll know exactly when your loan must be repaid.

Unsecured personal loans tend to be easier to qualify for than secured lines of credit and secured loans.

You can often choose the repayment term based on what works best with your cash flow. Loans usually can be paid off in between 6 and 60 months.

Personal loans are ideal for covering large one-time fixed expenses, such as a costly home renovation or car repairs, when you don’t plan to borrow anymore funds.

A personal loan can be great for consolidating debt. Not only could you have a lower interest rate, you’ll only have one payment to worry about.

Things to Keep in Mind

Unsecured personal loans tend to come with higher interest rates than secured lines of credit and secured loans.

If you’d like to borrow additional funds, you may be required to apply for a new loan.

Personal loans tend to come with a strict repayment schedule. If you’d like a more flexible repayment schedule, you might consider signing up for a line of credit instead.

What Are Personal Loans Usually Used For?

A personal loan can be used towards a variety of purposes. Common uses for personal loans in Canada are home improvement projects, debt consolidation, paying off overdue bills, paying for emergency or medical expenses, and much more. It is important to remember that these purposes will have to be articulated at the outset of the borrowing relationship with the lending institution. Banks and lenders most often use the loan purpose as one of the factors to assess the level of credit risk – probability that the borrower will be able to successfully repay the loan. 

Frequently Asked Questions About Personal Loans

How Are Personal Loan Interest Rates Calculated?

They are calculated through a combination of borrower-specific (income, credit score, assets etc.) and macroeconomic (central bank rates, inflation) factors. Interest rates (APR) on personal loans can be as little as 4% but can go up to 40% and more. 

Can I Pay Off a Personal Loan Quicker than the Life of the Loan?

Typically, personal loans do not come with prepayment penalties. However, it is important to confirm that with the lender prior to prepaying the loan. If the lender allows this, the benefits of prepayment could include lower interest costs over the life of the loan.

What Do I Need to Get a Personal Loan in Canada?

While different lenders will have different requirements for minimum credit scores, credit history and income levels, the baseline requirement for borrowers includes Canadian residency, steady employment, being 18+ years of age, and having a Canadian bank account.

How Much Can I Borrow Under a Personal Loan?

The precise amount depends on whether the borrower is willing to put up asset collateral, as well as the level of income and credit history they possess. Personal loans are typically between $500 and $10,000 but can be much higher. 

What Is the Difference Between Secured and Unsecured Personal Loans?

Depending on the purposes of the loan and the profile of the borrower, both have individual merits. With unsecured loans, the borrower does not have to risk any personal assets such as their vehicle or even their home, in the event they cannot repay the loan. However, the interest rates are typically higher on unsecured loans, and they are smaller in size, due to the extra risk for the lender. Secured loans, on the other hand, such as car title and home equity loans, use the borrower’s assets as collateral. This makes the loans less risky for the lender, and the borrower can take out a larger sum of money at a lower interest rate.

About the Author:

Sean Cooper is the bestselling author of the book, “Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians”. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. Sean is a personal finance journalist, money coach and speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense.