Canadians with poor or no credit history have a new way to borrow: so-called savings loans.
Savings loans have only been available in Canada for a few years, several sources told Global News, but they appear to be catching on in a country where average household debt has reached 167 per cent of disposable income.
Savings loans are a form of secured credit that may help borrowers build their savings and credit histories. Companies that sell them or tell clients about them describe them as a financial innovation that caters to needs unmet by any other financial product.
However, these loans usually come with high interest rates and sometimes steep fees. And there is no guarantee that they will make a significant difference in borrowers’ credit scores.
How savings loans work
No deposit needed
Canadians with low or no credit history usually only have access to secured credit. “Secured” normally means that to borrow, say, $1,000, you need to have an equal amount saved up that you leave with the lender as a security deposit. This ensures lenders won’t lose any money if you, a high-risk borrower, were to default on your payments.
This type of loan is meant to show credit bureaus that you can make disciplined debt repayments. The point is to improve your credit history so you can get access to credit without a security deposit and, eventually, with less scrutiny and at lower interest rates.
But what if you have no cash at hand for a security deposit?
Here’s where savings loans come into play. Unlike traditional secured credit, these loans don’t require you to have money saved up to use as a deposit. Instead, lenders will set a sum equal to the amount of the loan aside in a separate account, usually a Guaranteed Investment Certificate account, which serves as security against the loan. You gain access to the money after you have made all scheduled payments or gradually, as you build up equity.
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Companies then report your debt payment history, which may help you establish or rebuild credit.
“The loan, when used properly, can enable customers to break a vicious credit cycle: the inability to receive credit to then build positive payment history to then improve their credit,” according to Daniel Winer of Refresh Financial, which offers savings loans in Canada.
“This type of product is widely utilized in the U.S. 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 called a “referral partner” of Refresh.
EasyFinancial, which offers installment loans, refers customers who may not qualify for its own loans or are looking to rebuild their credit to Refresh, according to Fiederer.
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High interest and fees
The catch with Refresh loans is that they come with high costs in fees and interest.
According to a Refresh loan application viewed by Global News, a customer taking out a $1,200 loan was charged a $200 set-up fee and 15.99 per cent in interest. The client had to make weekly payments of $9.70 over three years to repay the loan, the fee and interest. The math works out to $511 in interest and fees for net savings of $1,000.
That’s a steep price to pay to either build up some savings or improve your credit, Douglas Hoyes, a licensed insolvency trustee at Kitchener-Ont.-based Hoyes Michalos, told Global News.
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 face between 14.95 per cent and 19.75 per cent in interest depending on how much you borrow.
Will savings loans 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 may assist in credit improvement contingent on good standing of other tradelines, low credit utilization and/or other factors,” according to Concord Lending Systems.
Falling behind on repayments on other loans or maxing out your credit card could tarnish your credit history even if you are diligently repaying your savings loan.
Taking out too many loans or credit card mail also spoil your score.
Even things like changing jobs or addresses frequently may affect your credit score, according to Hoyes, the licensed insolvency trustee.
Savings loans vs. other ways to save or boost your credit score
Hoyes is skeptical of savings loans as a means of either building savings or boosting your credit score.
If you’re trying to build up your savings
If your goal is saving money, Hoyes said, you can simply squirrel away into a Tax-Free Savings Account.
Referencing 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 placing $9.70 a week, through automatic payroll deductions, into some form of savings account like a TFSA. If he had, after three years, he would have $1,513, plus a little bit of interest, not $1,000.”
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If you’re trying to build your credit score
If you’re trying to build a credit history or boost your credit score, Hoyes advised turning to a secured credit card.
A secured credit card, such as the Home Trust Secured Visa, will cost you just $60 a year in fees and nothing in interest, as long as you avoid carrying a balance. Late payments incur interest of 14.9 per cent, or 19.99 per cent for the no-free version of the card. Repayments to a secured credit card should show up on your credit report, helping to build or rebuild 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 favourably than ‘revolving credit’ like a credit card, because it demonstrates commitment to making regular payments of the same amount for an extended period of time.”
Credit cards, he added, “often allow for payment of just minimum amounts, which also results in a cycle of debt effect and higher effective interest when it’s all said and done.”
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The dilemma facing Canadians considering savings loans is whether steep borrowing costs are worth the possibility that such loan programs will help them fix their credit faster than other, cheaper alternatives. (Canadians should keep in mind that no one other than credit bureaus knows exactly what credit score formulas entail, so there is no guarantee that certain types of credit will repair credit histories significantly faster than others.)
Canada’s financial consumers watchdog warned about loans meant to repair credit
On Wednesday, the Financial Consumer Agency of Canada (FCAC) issued a consumer alert urging Canadians to be “cautious” when turning to services that promise to help them pay off their debt or repair their credit.
The financial consumer watchdog mentioned companies that “offer you a loan suggesting it will help repair your credit score.”
Loans Canada, a company that refers customers to Refresh Financial, said “there are some similarities” between the loans described in part of the FCAC release and savings loans. However, it said that the savings loans to which it directs its clients help them build savings and credit history, better understand their credit and finances, and allow them to gain access to a portion of their savings before the end of the loan term.
Refresh and Concord told Global News they did not believe the FCAC press release refers to their products.
The agency noted that with some lenders promising loans that can help build credit, “you may never actually receive any money because the company will tell you the loan amount will cover its services or programs.”
That is not the case with Refresh and Concord, to Global News’s knowledge.
And while other businesses, according to FCAC, make overblown promises about their ability to “repair” credit, Refresh and Concord were clear with Global News that their loans do not serve to adjust data on an individual’s credit profile.
When referring to loans that can help improve your credit score, however, the FCAC also wrote: “Be aware this type of loan usually has a high interest rate.”
That warning applies to all savings loans reviewed by Global News.