Unsecured loans come in two different varieties: personal lines of credit and personal loans.
Let's take a quick look at each.
Personal lines of credit: This is revolving credit that functions similar to a credit card, where you have a credit limit that renews each month and you never pay interest on the amount you don’t use.
Personal loans: These are a type of installment loan that you must pay back by a set day, and you must make regular payments until the full amount is repaid. Unlike lines of credit, you must decide how much money you want at the onset and when you’ve paid the amount owing, you are done with that loan. For example, if you borrow $5,000 and then pay it back, and you later need another $5,000, you’ll have to apply for a new loan.
In addition to these two types of loans, unsecured loans can either be fixed-rate or variable-rate. Here’s the difference between the two:
Fixed-rate: A fixed-rate loan means the interest rate on your loan stays the same until you have repaid it. The rates on these are typically higher than what you’d find on a variable-rate loan, though you eliminate the risk of your interest rate ever rising. The lender will work with you and price this rate based on a variety of factors, your credit score being the most important. The higher your credit score, the lower your interest rate will be.
Variable-rate: Unlike a fixed-rate loan, the interest rate on a variable-rate loan can change depending on market conditions. Variable loans will decline if the Bank of Canada lowers its key interest rate, however, they will rise if the central bank reverses its decision and raises interest rates. These loans are riskier than fixed-rate loans, with the tradeoff being that you initially get a lower interest rate and have the potential to see your monthly payments decline if interest rates go down.