There are many reasons and instances where one should get a personal loan, but there are also equally as many instances when you shouldn’t take out a personal loan. In this article, we’ll go through instances where taking out a personal loan is unwise and why. If you’re considering a personal loan in Canada, keep reading to find out whether a personal loan is right for your situation.
What Does Annual Percentage Rate (APR) Mean?
Before discussing when to take out personal loans, it’s important to understand what an Annual Percentage Rate (APR) is. It includes not just interest rates, but also any costs associated with you taking out the loan. Lenders in Canada are obligated to tell you the APR before signing for a loan. The APR basically comprises how much you are paying off outside of the principal amount.
APR numbers are sky high if you are applying for a loan with a bad credit score. Any late payments will hurt your credit, which will lead to a lower credit score and even higher fees for any future loans you consider taking.
Instances When You Shouldn’t Take Out a Personal Loan in Canada
- To Pay Off Debt
Taking out more debt to pay off a pre-existing debt is just as backwards as it sounds. Although it may help you pay your due payment, it will only get you in even more debt, which means more debt you can’t pay off. That doesn’t even cover the impact it will have on your credit.
The worse your credit is, the higher your non-principal costs will be. If you’re in debt and can’t pay it off, your low credit score will lead lenders to increase your loan’s interest rate and fees. This means you’ll have an even higher annual percentage rate (APR). Overall, more money comes out of your pockets to pay it back.
Instead of using a loan to pay off your debts, you should speak to a professional about healthy debt repayment options available to you.
- To Purchase a Vehicle
Generally, auto loans are a better choice for purchasing a vehicle than a personal loan. Since a vehicle is registered to your auto loan, it’s what’s called a secured loan. A secured loan is a loan secured by some kind of collateral. In the case of an auto loan, this collateral would be your car. Therefore, auto loan lenders tend to offer better interest rates and fees, some may even offer a 0% APR for a limited time.
A personal loan can still suffice, but you should be mindful before choosing the personal loan path. A personal loan will usually have higher fees and interest rates. A personal loan works well when you’re not purchasing from a dealership, such as buying a used car from someone online.
- For a Down Payment on a House
Your down payment is meant to reduce the risk of lending to you, which is why some lenders will not accept loans as a down payment at all. Taking out a loan for a down payment will only demonstrate to lenders that you’re a high risk mortgage applicant. In general, there is a high chance your mortgage application will be denied if they see a large amount of debt on your credit report.
If your mortgage lender does decide to take your personal loan as a down payment, they’ll most likely offer an increased interest rate.
To Fund an Unnecessary Expense (i.e. Vacation)
Loans taken out to fund an unnecessary purchase will only hurt your credit score and leave you vulnerable to missing payments and accumulating debt. Despite this, many still take out loans to fund vacations, luxury items, weddings, home renovations, cosmetic procedures, and gambling. This type of spending habit is not sustainable.
It’s not that you aren’t allowed to spend money on things that aren’t essential. Everyone deserves the opportunity to treat themselves now and again, but don’t let yourself fall into debt for superfluous purchases. Instead, come up with a savings plan to fund these purchases. It is infinitely safer for your financial wellness and prevents you from falling into a debt cycle that can hurt your future.
If I can’t take out a personal loan, what should I do instead?
If you find yourself thinking of taking out a personal loan for the above reasons, it might be time to reassess your spending habits and overall financial situation. Many Canadians lack the financial literacy they need to empower themselves, but it doesn’t have to be that way. We’ve developed free financial literacy guides to help you understand various aspects of your finances, including credit and debt.
