There are many ways to borrow money and many reasons why you might want extra financing. Some loans can help you achieve a specific goal in your life, such as buying a house. Other borrowing options are designed to make day-to-day purchasing more convenient. Learn more about common ways to borrow money, and the risks of borrowing too much.
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What are some common ways to borrow money?
There are many ways you could borrow money if you need to pay for something without using cash or debit. Some of the most common ways are:
- Credit cards – Credit cards are used to make purchases on credit, meaning you don’t pay for them at the time but owe the card issuer the money. There are many types of credit cards and you must apply for them. The features offered and the interest rates you owe on your purchases will vary. If you pay off the balance in full each month, you likely won’t pay any interest.
- Personal loan – You can get a term loan or line of credit from a bank, trust company, credit union or finance company. With a term loan, you repay the loan over a fixed period of time at a fixed rate of interest. With a line of credit, you’re pre-approved to borrow up to a set limit. You can borrow and repay at any time, as long as you make the minimum monthly payment.
- Overdraft protection – This is a type of coverage on some chequing accounts. Overdraft protection covers a short-term cash shortage in your bank account. It also covers NSF (not sufficient funds) cheques. You may pay a monthly charge for this service, or you may pay only when you need to use the service. You will also pay interest on the money you borrow. These interest charges can be high.
- Mortgage – This is a long-term loan you get to buy a home. With a mortgage, interest rates are lower than consumer borrowing options like credit cards, because your home secures the loan. You have different options for how and when you repay a mortgage.
- Home equity loan – This is a type of loan that lets you borrow against the money you have invested in buying your home. The more you’ve paid down on your mortgage (your equity), the more you can borrow. Again, interest rates are often lower because your home secures the loan. Learn more about what to consider before borrowing against your home.
- Student loan – A student loan is designed specifically to help you pay for post-secondary education. Student loans are both provincial and federal. Learn more about student loans in Canada.
- Lease – A lease is a long-term rental on a product, such as a car. It works a bit like a loan, because you make regular payments at a fixed rate of interest. The payments are usually lower than payments on a loan for the same term. The big difference is that at the end of the lease, you don’t own the product. But you may have the option to buy the product for what it is worth at the end of the lease. Many leases set special conditions you must meet. For example, a car lease can limit how many kilometres you can drive each month.
Borrowing against your RRSP – In some cases, you may be able use money in your RRSP as collateral for a bank loan. This may not be allowed depending on your bank policy or RRSP administration agreement. Make sure you get expert advice from a tax planner or financial advisor before you go ahead. If you don’t follow the rules, you’ll have to pay tax on the RRSP money you use as collateral.
There are also ways you can borrow from your RRSP. Through Canada Revenue Agency’s Home Buyers’ Plan and Lifelong Learning Plan, you can borrow money from your RRSP without paying tax to buy your first home or pay for education. This can reduce how much you would owe for a mortgage. However, when you borrow from your RRSP, the money you take out of the plan won’t be growing tax-free for your retirement and you will have to pay it back.
What are some reasons to borrow money?
You may have heard people talk about good debt versus bad debt. The difference between good or bad debt might look a little different for different people. Generally speaking, people refer to good debt when they are borrowing money for something that will add value to their life or produce more wealth for them in the long run.
Examples of good debt might include:
- Taking on a mortgage to purchase a home, which may increase in value the longer you own it.
- Taking on a student loan, which will enable you to get higher education and qualify for employment.
- Borrowing to start a business, such as a small business loan, which could grow your wealth.
Some types of debt can improve your life, however, you still require a plan to pay them off. Before you borrow, make sure to ask a few key questions, including finding out what the interest rate is and whether it might change.
The term bad debt usually describes debt used to purchase something that will decline in value, or will not add anything of value to your life in the long term. Examples of this type of debt might include:
- Using credit to pay for expensive purchases such as a vacation, electronics or new furniture, without having a plan to repay them. Try to plan and save for occasional expenses like a new TV or a vacation.Â
- Borrowing to cover monthly bills or regular expenses. This can end up costing you more in the long run if you can’t repay them and owe interest. Sticking to a budget will help you pay your bills without having to borrow.
Taking on high interest debt that will be difficult to repay, such as payday loans, or unsecured personal loans. These types of loans can often have interest rates higher than average consumer credit options like credit cards. Depending on how long it takes to repay them, they can cost more in interest than the amount of the original loan.
Debt consolidation is the process of combining multiple debts into one. Try the debt consolidation calculator to see to calculate what your new monthly payments would be, how soon you could be debt free, and how much your total interest amount would be when you consolidate your debts. And the Pay Off Credit Cards and Debt Calculator can give you monthly payment plans for up to eight credit cards or loans, including lines of credit and mortgages. It will show you the order in which you should pay off the debts, and how long it will take
What is a buy now, pay later plan?
Buy now, pay later (BNPL) plans have become more common, especially as an option offered by online payment systems. These plans offer you the option to pay for your purchase in instalments with low or no interest, rather than paying the entire price up front. These payments are typically done through pre-authorized payments to your credit card or bank account.
The risk of BNPL plans is that you must be able to make these post-dated payments in full, otherwise you may be charged additional fees. It can also be tempting to spend too much, since you’re not required to pay for the purchase in full.
What are the risks of borrowing too much?
Any money you borrow needs to be paid back. That means there are risks of borrowing too much, including:
- It may become a habit. You might find it easier to put large purchases or occasional expenses on a credit card. But unless you pay off your credit card right away, your debt will grow each month.
- It takes away money from other important needs. When you borrow money, you have to pay interest. That’s money you could put toward savings or spend on other things.
- It can harm your credit rating if you don’t pay your bills. If you fall behind on your bills, you may not be able to borrow more money when you need it or you may have to pay a higher rate.
If you have a poor history of being able to repay your debts, this will negatively affect your credit history. As a result, it may be difficult to get loans in the future. If you’re finding it hard to pay off your credit card each month, or are regularly exceeding your credit limit, this may be a sign to get help managing your debt and spending. Learn more about how your credit report works.
If you’re considering borrowing money to invest, such as for a margin account, be aware that taking on debt involves more risk than paying for an investment outright with cash. Whether your investment makes money or not, you still have to pay back the loan plus interest. If you rely solely on investment returns to cover your borrowing costs and your investment falls in value, you could end up defaulting on the loan. Remember, no investment is without risk.
Summary
Borrowing money can help you reach important goals in your life. It can also make everyday spending more convenient. But there are important things to keep in mind about borrowing:
- There are several common ways to safely borrow money in Canada, including credit cards, mortgages, and student loans.
- Each type of loan or use of credit comes with conditions, like interest rate and terms of repayment.
- It’s important to have a plan to repay your loan, no matter what kind it is.
- People often refer to good debt as the kind that will help you achieve valuable goals, such as a mortgage or student loan.
- Bad debt is often used to mean borrowing that won’t add value to your life, or will simply add to your consumer spending debt.
- Your borrowing activity is tracked on your credit report.
- If you have a history of being unable to repay your debts on time, this could harm your credit report.
