Have you heard of savings credit? Think carefully before you sign up – National
Canadians with poor or no credit history have a new way to borrow: savings loans.
Savings loans have only been available in Canada for a few years, multiple sources told Global News, but they appear to be gaining traction in a country where average household debt has reached 167% of disposable income.
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Savings loans are a form of secured credit that can help borrowers build up their savings and credit history. The companies that sell them or tell their customers about them describe them as a financial innovation that addresses needs not met by any other financial product.
However, these loans usually come with high interest rates and sometimes high fees. And there is no guarantee that they will make a significant difference in the credit scores of borrowers.
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How savings loans work
No deposit required
Canadians with little or no credit history generally only have access to secured credit. “Secured” normally means that in order to borrow, say, $ 1,000, you have to save an equal amount that you will leave with the lender as a security deposit. This ensures that lenders won’t lose money if you, a high-risk borrower, don’t make your payments.
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This type of loan is meant to show the credit bureaus that you can make disciplined debt repayments. The goal is to improve your credit history so that you can access credit without a security deposit and possibly with less control and at lower interest rates.
But what if you don’t have money on hand for a security deposit?
This is where savings loans come in. Unlike traditional secured credit, these loans do not require you to have money on hand to use as a deposit. Instead, lenders will set aside an amount equal to the loan amount in a separate account, usually a guaranteed investment certificate account, which serves as collateral against the loan. You have access to the money after you have made all scheduled payments or gradually, as you build equity.
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Businesses then report your debt payment history, which can help you build or restore credit.
“The loan, when used correctly, can allow customers to break a vicious credit cycle: the inability to receive credit and then build a positive payment history and then improve their credit,” says Daniel Winer of Refresh Financial, which offers savings loans in Canada. .
“This type of product is widely used in the United States in over 1,500 credit unions,” said Andrea Fiederer, executive vice president and chief marketing officer of Goeasy. Goeasy is the parent company of EasyFinancial, which Fiederer has called Refresh’s “reference partner”.
EasyFinancial, which offers installment loans, refers clients who may not be eligible for its own loans or who are looking to replenish their credit to Refresh, according to Fiederer.
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High interest and fees
The problem with Refresh loans is that they come with high fees and interest.
According to a Refresh loan application seen by Global News, a client taking out a $ 1,200 loan was charged a set-up fee of $ 200 and interest of 15.99%. The client was to make weekly payments of $ 9.70 over three years to repay the loan, fees and interest. The calculation gives $ 511 in interest and fees for a net saving of $ 1,000.
That’s a hefty price to pay for racking up savings or improving your credit, Douglas Hoyes, Licensed Insolvency Trustee at Hoyes Michalos, based in Kitchener, Ont.
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At Concord Lending Systems, which operates only in Ontario, you can get a savings loan without paying a set-up fee, but you’ll still have to pay between 14.95% and 19.75% interest depending on how much you borrow.
The company hopes to be able to lower these tariffs in the future, “in order to [credit] rebuilding more affordable for larger segments of the population, ”the company’s chief operating officer, Tim Ermakov, told Global News.
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Will Credit Savings Really Improve Your Credit?
Making timely payments through a savings loan can definitely help your credit scores. However, there are many other factors that affect your credit history.
“Timely repayment of your obligations can help improve credit based on the good reputation of other business lines, low credit utilization and / or other factors,” according to Concord Lending Systems.
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Falling behind on other loan payments or maxing out your credit card could tarnish your credit history, even if you diligently pay off your savings loan.
Taking too many loans or credit card mail also ruins your score.
Even things like changing jobs or addresses frequently can affect your credit score, according to Hoyes, the Licensed Insolvency Trustee.
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Savings Loans Versus Other Ways To Save Or Increase Your Credit Score
Hoyes is skeptical of savings loans as a way to either build up savings or increase your credit score.
If you are trying to build up your savings
If your goal is to save money, Hoyes said, you can just jump into a tax-free savings account.
Referring to the Refresh loan application viewed by Global News, a blog post on the Hoyes Michalos website noted, “In terms of saving money, the client would be much better off investing $ 9.70 per week. , through automatic payroll deductions, in a form of savings account. like a TFSA. If he had, after three years he would have $ 1,513 plus a little interest, not $ 1,000. “
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If you are trying to build your credit score
If you’re trying to build a credit history or increase your credit score, Hoyes advised you to turn to a secured credit card.
A secured credit card, such as Home Trust Secured Visa, will only cost you $ 60 per year in fees and no interest, as long as you avoid carrying a balance. Late payments incur interest of 14.9%, or 19.99% for the free version of the card. Refunds to a secured credit card should show up on your credit report, which will help you build or replenish your credit.
At Refresh, Winer told Global News via email that, “in our conversations with mortgage brokers and long-term lenders, an installment loan is viewed more favorably than a” revolving credit “such as a credit card. credit because it demonstrates a commitment to make regular payments of the same amount over an extended period.
Credit cards, he added, “often allow you to pay only minimum amounts, which also results in a cycle of debt and higher effective interest when all is said and done.”
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The dilemma faced by Canadians considering savings loans is whether the high borrowing costs are worth the possibility that such loan programs will help them repair their credit faster than other cheaper alternatives. (Canadians should keep in mind that no one other than the credit bureaus knows exactly what credit score formulas entail, so there is no guarantee that certain types of credit will repair credit history. much faster than others.)
Watchdog of Canada’s financial consumers warned against loans to repair credit
On Wednesday, the Financial Consumer Agency of Canada (FCAC) issued an alert to consumers urging Canadians to be “careful” when they turn to services that promise to help them pay off their debt or repair them. their credit.
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The financial consumer watchdog has mentioned companies that “are offering you a loan suggesting that it will help you repair your credit score.”
Loans Canada, a company that refers clients to Refresh Financial, said “there are some similarities” between the loans described in part of the FCAC press release and savings loans. However, he said the savings loans he directs his clients to help them build savings and credit history, better understand their credit and finances, and allow them to access some of their own. savings before the end of the loan term.
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Refresh and Concord told Global News they didn’t think the FCAC press release referred to their products.
The agency noted that with some lenders promising loans that can help create credit, “you may never receive any money because the company will tell you that the loan amount will cover its services or programs.” .
This is not the case with Refresh and Concord, to the knowledge of Global News.
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And while other companies, according to the FCAC, are making exaggerated promises about their ability to “fix” credit, Refresh and Concord have made it clear to Global News that their loans are not used to adjust profile data. of an individual’s credit.
However, referring to loans that can help improve your credit score, FCAC also wrote, “Be aware that this type of loan usually has a high interest rate. “
This disclaimer applies to all savings loans reviewed by Global News.