Budget 2021 announced the Government of Canada's intention to consult on fighting predatory lending by lowering the criminal rate of interest in the Criminal Code of Canada applicable to, among other things, installment loans offered by alternative lenders, including payday lenders.
This consultation paper seeks feedback on questions related to the criminal rate of interest and the provision of high-cost installment loans in Canada.
High-cost installment loans appear to be the most widely held high-cost lending product in Canada. In a recent study conducted by the Financial Consumer Agency of Canada (FCAC), 44 per cent of consumers who had taken out high-cost credit reported taking a high-cost installment loan in 2020.
The criminal rate of interest in the Criminal Code, which is currently set at 60 per cent effective annual interest, is applicable to most lending products in Canada (e.g. installment loans, lines of credit, auto loans, auto title loans, credit cards, and more). The only exceptions are payday loans (loans for values of $1,500 or less and for a term of 62 days or less) offered by licenced or specifically authorized persons in provinces that have enacted consumer protection laws and where the province has been designated by the federal Governor in Council. Nine provinces have been designated Footnote 1 . The Criminal Code provisions governing payday loans are not the subject of this consultation paper.
The Criminal Code makes it an offence to: (1) enter into an agreement or arrangement to receive interest at a rate exceeding 60 per cent; and, (2) actually receive interest at a rate exceeding 60 per cent.
The Criminal Code defines "interest" as including the aggregate of all charges and expenses, such as fees, fines, penalties or commissions (or similar charges or expenses). It excludes a number of other charges, such as insurances charges, overdraft charges, or amounts to be paid when discharging a mortgage. It also defines "criminal rate" as an effective annual rate of interest (meaning that it includes compound interest) and is calculated using generally accepted actuarial practices and principles. The Supreme Court of Canada has confirmed the comprehensive nature of the definition and has held that determining whether something is "interest" depends on the substance of the transaction.
The criminal rate of interest in Section 347 of the Criminal Code was first introduced in 1980. The rate was not established with the intent of being a financial consumer protection measure to combat the growth of high-interest loans; rather, the provision was meant to deter loan-sharking and other predatory practices where lenders offer credit at high interest rates and employ intimidation, violence, or threats of violence to enforce repayment. A fixed interest rate of 60 per cent was included in the offence to provide a level of certainty; an objective standard was expected to be easier to prove, rather than the prosecution having to prove that there was violence or intimidation associated with the loan.
There is no universal definition of a "high-cost" or "high-interest" loan, either in Canada or internationally. Perceptions about the cost of credit are relative and influenced by various factors, including the type of lending products, collaterals, and prevailing interest rates for conventional lending products from banks or credit unions.
For the purposes of this paper, "high-cost lending" refers to financial credit products with high interest rates and/or fees. These products are generally provided by alternative lenders (e.g. lenders other than banks or credit unions). Examples of the largest alternative lenders in Canada include Cash Money, MoneyMart, Easy Financial, Fairstone Financial, among others.
High-cost installment loans are personal loans that give a borrower a fixed sum of money (the principal) that is repaid with interest in installments over an agreed period of time (typically several months to a few years). Alternative lenders, including payday lending institutions also typically offer longer-term, higher-value installment loans.
These installment loans have advertised interest rates as high as 47 per cent per year. Once the ancillary non-interest fees and charges associated with loans are included, and with frequent interest compounding, many installment loans have effective annual interest rates of just below or almost equal to the criminal rate of interest of 60 per cent.
In addition, some high-cost installment loans are similar to payday loans, where there are shorter repayment periods (such as 90 to 150 days), but are for amounts greater than $1,500, which is the maximum allowable amount for a payday loan that can be exempt from the criminal rate of interest.
The FCAC's 2020-21 COVID-19 Financial Well-being Survey showed that approximately 2 per cent of Canadians used an online non-bank lender or payday loan company in the previous 12 months. This is consistent with previous survey data collected by the FCAC. Of those respondents who had used an online or payday lender, roughly 44 per cent took out an installment loan with fixed payments over a specific number of months. The rates of those who use payday or online lenders is higher among certain vulnerable populations, including low-income households, individuals with lower educational attainment, single parents, and Indigenous Canadians.
Federally-regulated banks are subject to the federal Financial Consumer Protection Framework, which includes strong measures to protect and empower consumers, including ensuring clear, simple and not misleading disclosures of information. The government also focuses on strengthening consumer education and enhancing financial literacy to assist Canadians in making informed financial decisions.
Provincially-regulated credit unions are also subject to strong consumer protection provisions established by the provinces. Provinces and territories have also put in place consumer protection rules for many alternative lenders, including payday lending institutions that offer high-cost installment loans. Given that each province and territory has its own consumer protection measures for lending products and practices, consumer protections related to business practices, disclosure of information, maximum interest rates, and complaint handling procedures, may vary across the country.
The criminal rate of interest was set at 60 per cent in 1980. It is a fixed rate and not linked to prevailing market rates. The rate has remained unchanged since its introduction.
When the criminal rate of interest was introduced, the Bank of Canada overnight rate was
21 per cent. At that time, the difference between the overnight rate and the criminal rate was 39 per cent.
Since 1980, the Bank of Canada overnight rate has been on a general downward trend, albeit with fluctuations. Despite recent increases, the rate remains at levels well below the 1980s. This means that the difference between the Bank of Canada overnight rate and the criminal rate of interest is nearly 60 per cent. This is a significantly larger difference than 40 years ago when the criminal rate of interest was introduced.
The government is interested in understanding whether the interest rate pricing set by high-cost alternative lenders is a reflection of the actual credit risk of the borrower, or whether the interest rates on these products are set simply to comply with the ceiling permitted under the criminal rate of interest.
While the majority of Canadians turn to banks and credit unions to access credit, many financially vulnerable Canadians may be less able to access credit or loan products from these types of financial institutions. Their lack of access may be due to outstanding debts, a lower ability to service debt, employment status, lower credit scores, previous bankruptcies, or other factors, including the lack of access to a physical branch location of a bank or a credit union.
These Canadians may turn to alternative lenders to access a variety of loan products, including high-cost installment loans, which generally carry significantly higher interest rates and fees compared to products offered by banks and credit unions.
While high-cost installment loans may help some Canadians address their short-term financial needs, they also have the potential to contribute to the vulnerability of financial consumers. When consumers who are already struggling to make ends meet take on additional debts, particularly with high borrowing costs, it may lead to a spiral of debt. These debts would further negatively affect borrowers' financial resilience when they encounter challenging life events, such as a reduction in income or a period of unemployment.
While lowering the criminal rate of interest will reduce the permissible interest rates for high-cost installment loans, underserved financial consumers may still require access to credit offered by alternative lenders to meet expected or unexpected expenses.
The government is interested in understanding the impact on the availability of credit to financially vulnerable Canadians if the criminal rate of interest is lowered significantly.
Since the criminal rate of interest is applicable to all credit products in Canada, except for payday loans made in accordance with section 347.1 of the Criminal Code, it is a very broad measure. Lowering the criminal rate of interest may have an impact on the maximum effective annual interest rate for other credit products used by a large number of financial consumers, including lines of credit, credit cards, certain auto loans, and auto titles loans, among others. Additional information on these products can be found in Annex A.
Beyond these more mainstream lending products, the level of the criminal rate of interest is also relevant for some short-term loan products. For example, in bridge financing for real estate transactions, funds are necessary for the purchase of a property that are not available at the time of closing, but are available a short time after. These types of short-duration loans may have a higher effective annual interest rate. Another example can be flat fee lending transactions between two individuals where a fixed interest or fee charge over a short period would equate to a much higher effective annual interest rate.
While financial necessity may drive some consumers to choose high-cost installment loans from an alternative lender, other consumers may choose these high-cost loan products without fully understanding the implications of this choice, or how this choice might affect their long-term financial well-being. For example, high-cost installment loans from alternative lenders often have continuous and frequent compounding terms, meaning interest is added to the loan every day, even if the borrower makes scheduled payments weekly, biweekly, or monthly. The effective annual interest rate, which includes the impact of compounding and more accurately reflects what the borrower will pay, may be much higher than the advertised annual interest rate. Consumers may not understand the difference between the advertised rate and the effective rate when considering a high-cost installment loan.
Furthermore, products may be subject to late penalty fees, non-sufficient funds fees, administration fees, and more. Certain lenders may even strongly encourage borrowers to take out creditor insurance on the product, which ensures the lender is paid in the event that the borrower is unable to pay. These additional non-interest charges can make the credit more expensive and may not be easily or fully understood by the consumer.
The FCAC works with stakeholders to raise public awareness about the costs of high-cost lending and alternatives to these loan products. Information is available on its website, and it provides tools to help Canadians choose appropriate borrowing products (e.g., credit card comparison tool).
The government is in the process of collecting feedback from all interested stakeholders. Your input will help us to gain a full understanding of the benefits and risks of amending the criminal rate of interest to address high-cost installment loans from alternative lenders, and help inform future policy directions on this issue.
For ease of reference, below are all of the questions that the Government of Canada is posing to stakeholders related to high-cost installment loans and lowering the criminal rate of interest:
Below is a brief discussion of some types of credit products used by Canadians that could be impacted or influenced if the criminal rate of interest were lowered. This is not an exhaustive list of credit products.
Lines of credit are flexible loans consisting of a defined amount of money that can be accessed as needed and repaid immediately or over time. A line of credit may be offered by traditional or alternative lenders and may be secured against assets (e.g. real estate), or may be unsecured. Fairstone Financial, and LendDirect, among others, are examples of alternative lenders who provide these loans.
It is difficult to identify the general rates charged by alternative lenders for lines of credit using publicly available information; however, some alternative lenders advertise rates of nearly 47 per cent on a line of credit of up to $10,000.
When borrowed from a bank or a credit union, interest rates on installment loans can vary significantly from a few percentage points above the Bank of Canada overnight rate, to just below 20 per cent, depending on whether the loans are secured (or unsecured) and the creditworthiness of the borrower. The interest rate is annualized and is charged against the average daily balance once per month. The amount borrowed, interest rate type (fixed or variable) and repayment period (or term) may also affect the interest rate offered.
A home equity line of credit (HELOC) is a type of line of credit, and since it includes a lien against a home, usually has lower interest rates similar to mortgages.
Subprime auto loans
A car or auto loan is a credit product that allows a consumer to borrow money in order to purchase a car. The car is registered as a security for the loan, meaning that the lender (e.g. bank or alternative lender) has certain legal rights to the vehicle until the loan is paid off.
"Subprime auto loans" are auto loans used to finance the purchase of a car by a person who has a low credit score or a limited credit history. Typically offered by alternative lenders, the interest rates for these loans are higher, ranging from 24 per cent up to nearly 47 per cent.
Auto title loans
Auto title loans are loans against the value of an automobile, and are generally only offered by alternative lenders, such as Money Mega Mart, Fast Action Finance, or Title Loans Online, among others. The loan includes a lien against the ownership of the car. While it has been difficult to determine the average interest rate for auto title loans offered in Canada, rates appear to be in line with those offered by alternative lenders on unsecured installment loans, varying between 30 per cent and 46 per centSince the loan includes a lien against the ownership of the car, if the borrower is unable to repay the loan, the lender may seize and sell the car to recover the borrowed money.
A credit card is an account that allows the borrower to purchase goods or services on credit, and repay over the short-term without interest, or over a longer-term with interest. .
Credit cards are very widely held financial products. There are approximately 75 million credit cards in Canada (or approximately 2.5 credit cards per adult), with 93 per cent of Canadian adults holding at least one credit card.
Some may consider credit cards as a high-cost lending product, as they typically have interest rates around or above 20 per cent, and may have other associated fees, including annual fees.
Individuals with lower credit ratings may be able to open an unsecured credit card account, but often with much higher interest rates. Other consumers may consider secured credit cards, in which a deposit is provided by the consumer, but which is seized if the balance goes unpaid.
Quebec, Nunavut, the Northwest Territories, and the Yukon have not sought exemptions from the criminal rate of interest for payday loans. As such, payday loans offered in these jurisdictions are subject to the criminal rate of interest. However, in Quebec, jurisprudence has established that annual rates of interest above 35% are excessive.