How much does borrowing money cost?

7 minute read

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Whether it’s to start a home renovation, consolidate your debt, or pay for unexpected expenses, borrowing money can be a useful tool to reach your goals. While borrowing does come with costs, knowing what to expect can go a long way towards improving your overall financial well-being.

To help you navigate this, we've created a comprehensive guide that covers what you need to know about borrowing money to meet your financial goals — along with practical tips to help you make decisions about your money.

Before we explore the different types of loans available, let’s go over some fundamental aspects of borrowing. The ‘cost of borrowing’ refers to the original amount that you borrowed, plus interest and any applicable fees you’re required to pay.

Now, let’s take a closer look at some key terms for a deeper understanding of the cost of borrowing.

The basics of borrowing

Principal amount

This is the initial sum you borrow, and it serves as the basis for calculating the total cost of borrowing. For example, if you borrowed $5,000 for a car loan, this would be your principal amount.

Interest rates

Loans either have fixed or variable interest rates. As the name implies, fixed rates don't change for the term of the loan, so your monthly payments stay the same. Variable rates fluctuate with market conditions, so they can increase or decrease over time.

Repayment terms

Your repayment terms specify the timeline and schedule to pay back the funds you borrowed. Shorter terms mean higher monthly payments but less interest overall, while longer terms mean lower monthly payments with more interest.

Secured vs Unsecured

Secured loans are backed by collateral so they pose a reduced risk to lenders, while unsecured loans aren't. Secured loans usually have lower interest rates, but failing to pay can put that collateral at risk. Unsecured loans generally come with higher interest rates to reflect the higher risk.

How does borrowing impact your credit score?

Your credit score is a reflection of your borrowing behaviours distilled into a triple digit number. This number tells lenders how trustworthy of a borrower you are, and can impact the rates you qualify for on your mortgage, personal loans, and more. Typically, the higher your credit score, the lower the borrowing costs. Actions such as paying bills on time, only borrowing what you need, and infrequently applying for credit can help you maintain a stronger credit score.

Regularly checking your credit scores will help you catch errors quicker and stay eligible for better rates. You can request a copy from one of the two major credit bureaus in Canada: Equifax and TransUnion.

Understanding your credit score

Your credit score is a three-digit number, ranging from 300 to 900, that lenders use to evaluate your eligibility for loans and determine what interest rate they’ll offer. Learn more about the best ways to improve your credit score.

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The benefits of being a reliable borrower

As mentioned earlier, establishing yourself as a responsible borrower comes with several perks. Here are just a few key ones:

It can boost your credit score. When you consistently pay back your loans when they’re due, it builds a strong credit history. Over time, this can boost your score and help make it easier to get future loans.
You could get better rates, too. Having a solid credit record can also mean loans with lower interest rates, saving you more in the long run.
It can move you closer to your goals. Strategic borrowing can be a powerful way to reach your long-term financial dreams, like buying a home or starting a new business. For example, taking out a mortgage could build your wealth down the line.

Different ways to borrow

Credit cards

For smaller purchases, credit cards help maintain healthy credit while paying for daily expenses. Many issue rewards or cash back on what you spend, but they carry higher interest rates that add up fast. Best used for everyday purchases you plan on paying off within the month.

Personal loan

If you're planning on making a bigger purchase, personal loans come with fixed interest rates and structured repayment terms, which make budgeting more predictable compared to credit cards. Best used for long-term investments, or consolidating debt.

Line of credit

If the unexpected happens, lines of credit offer flexibility by allowing you to borrow funds as needed, up to a set limit. They typically have lower interest rates compared to credit cards. Best used for emergency funding for unexpected expenses.

The do’s and don’ts of smart borrowing

ALWAYS

Pay on time: Automatic payments are a great way to ensure you stay on tarck with repaying what you borrowed.
Talk to an expert: Talk to an advisor about your goals, and which borrowing options would help you the most. This conversation should cover term lengths, interest rates, and how they can help you secure the best one for your situation.
Use loan calculators: Take advantage of online loan calculators to estimate total costs, monthly payments, and to plan your borrowing strategy effectively.

NEVER

Borrow more than you need: Resist the urge to borrow excessively. Only take out a loan for the amount necessary.
Ignore fees: Be aware of all fees associated with the loan, including late payment penalties and other charges. Read your agreements carefully to know these costs beforehand and avoid headaches down the road.
Neglect your credit score: When it comes to borrowing, your credit score matters. Ignoring it could mean higher interest rates or even rejected applications but nurturing it could mean better terms and interest rates.

The bottom line on borrowing money

Being able to anticipate the true cost of borrowing money is crucial for making informed financial choices. Not only that, but understanding the associated costs, including interest and fees, allows you to better manage your money.