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Here’s a very useful article from moneyproblems.ca that explains the basics of personal loans, and how to pick the right one for you.

What is a personal loan? That’s easy – its money that an individual borrows personally. What does it look like? That’s tough – personal loans come in all sorts of different shapes and sizes.

Some examples of personal loans might be:

  • Your parents loan you $1,000 so that you can pay first and last month’s rent
  • A bank loans you $15,000 to pay off your credit cards (this is also called a consolidation loan)
  • A finance company loans you $25,000 to buy a car (this is also called a car loan)

All personal loans have one thing in common: the loan is for a fixed amount. (In our first example, your parents loaned you $1,000). This is different from a line of credit where you have authorization to use a certain amount of credit or a credit card where you have a spending limit.

Other characteristics that are usually found in personal loans include:

1.Repayment terms: how much and how often will you make a payment towards this personal loan? In the first example, your parents might not set repayment terms – “just pay us back when you can”. In most cases, the lender(the person or business that is granting you the loan) will set specific repayment terms. The most common is a requirement to make payments once a month, on the same day every month.

2.Interest rate: interest is the term used to describe the amount that the lender is charging you to borrow the money. It is almost always set as a percentage of the amount borrowed on an annual (also called per annum) basis. Using our second example, the bank might loan you $5,000 at a rate of 10%. That means that the bank is charging you 10% of $5,000 adjusted for the amount of time the money is outstanding. Go to our page on interest for a more detailed explanation of interest rates.

3.Security: often, lenders require people borrowing money to pledge things that they own as collateral for a loan. In the event that you fail to make the required payments, the lender may have the right to seize and sell the item pledged to pay off the debt. Go to our page on security for more detailed information on security. Its important to note that not all personal loans are secured. Lenders only ask for security for large loans and in situations where they have concerns about a borrowers ability to repay the debt.

4.Guarantors/co-signers: a guarantor and/or co-signer is someone who pledges to repay your debt if you are unable. Not all personal loans have guarantors or co-signers. Like security, lenders usually request guarantors for large loans and in situations where they have concerns about a borrowers ability to repay a debt.

Lets go back to our original personal loan examples and add some details based on the characteristics set out above.

  • Your parents loan you $1,000 so that you can pay first and last month’s rent

The fixed amount of this loan is $1,000. If your parents said, “just pay us back when you can” then there would be no repayment terms. There probably wouldn’t be any interest or security or guarantors either.

  • A bank loans you $15,000 to pay off your credit cards. This is also called a consolidation loan.

The fixed amount of this loan is $15,000. Typical terms for this type of loan might be repayment on a monthly basis for the next 4 years (48 months) at 10 % interest. If the bank had concerns about your ability to repay the debt they might ask for security, although for this type of loan they usually prefer a co-signer (someone to pay if you cannot).

  • A finance company loans you $25,000 to buy a car. This is also called a car loan.

The fixed amount of this loan is $25,000. Typical terms for this type of loan might be repayment on a monthly basis for the next 5 years at 9 % interest and as security for the loan, the finance company would register a lien on the car. A lien is the legal term used to describe the finance company’s claim on your car if you don’t repay the debt. In some cases, if the lender is concerned about your ability to repay, they might ask for a co-signor, even though they have security.

Recall that we said that personal loans come in all sorts of different shapes and sizes. It would be impossible to cover all of the variations available in the market place today. Go to our links page for financial institutions and spend some time viewing the websites for the companies that are listed. This should give you an appreciation of just how many different types of loans are available today.

If you are thinking about applying for a personal loan, we’d like to offer some advice:

1.Think twice. Do you need something badly enough to justify borrowing for its purchase? Interest can be very expensive.

2.Self-assess. How much can you afford to pay every month? Have you prepared a monthly budget? How long are you willing to make payments? Your answers to these questions will determine how much you may comfortably borrow.

3.Credit Report. What’s your credit rating? Do you make all of your required payments on time? Have you bounced any cheques in the last year? Have you failed to repay an amount that you owed? A bad credit rating will seriously impair your ability to borrow without security and/or a co-signer.

4.Shop around. If you determine that borrowing is the thing to do, if you have the ability to repay and if your credit rating is good, shop around before you sign any contract to borrow money. A loan is no different from anything else that you might buy. If one financial institution will approve you for a loan, odds are, so will a second. Its okay to negotiate for lower interest, longer repayment periods, or any other aspect of the loan that you might like to change.

Remember: all loans must be paid back, so only use credit when it is absolutely necessary.

[end of article]

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