Recently, the Ontario Ministry of Government and Consumer Services (Ministry) asked interested parties to submit their recommendations on potential ways to strengthen consumer protection for those individuals who may use alternative financial services (AFS) such as payday loans and quick cash installment loans, as well as those who may find themselves facing debt collectors.
As one of Ontario’s largest personal insolvency firms, we see first-hand the devastating financial impact the excessive use of high-cost, subprime lending products has on every day Canadians. As many who read our blog know, I am particularly enraged by the practices of payday lenders and other lending products designed to entrap individuals in a cycle of borrowing against their own financial best interest. With this in mind, our firm submitted a report to the Ministry outlining our findings and suggestions. Below is a summary of changes we believe would ensure that consumers using these products, do so with full knowledge and significantly more protection than they have today.
Improved Disclosure Surrounding True Cost
There is an apparent ‘gap’ between usury laws embedded in federal Criminal Code legislation and existing consumer protection laws, both federal and provincial. Payday and similar loan products slip through the cracks in these laws regarding what they are able to charge consumers. Usury is defined as 60% annualized interest in Canada, and yet, payday lenders charge in excess of 390% (based on a maximum rate of $15 per $100 in 2018) interest based on the Ministry’s calculations as shown in this great youtube video about how to calculate the annual equivalent interest rate on a payday loan by Preet Banerjee, financial writer for the Globe & Mail.
We believe that AFS products should be explicitly included in federal laws that define allowable interest and other charges.
In addition, disclosure of the true costs of borrowing needs to be enhanced significantly. Today, payday lenders promote the ‘affordability’ of their product as costing only $15 interest on $100. Since most consumers interpret this to mean 15%, it is somewhat disingenuous and payday lenders know that.
The total cost of borrowing should include all fees and interest, and be clear and understandable. Disclosure should include:
- The true annualized interest rate, including fees and costs of default (so in most cases 390%).
- The potential projected cost of borrowing in real dollars. Rather than saying the $300 loan will cost $45 in two weeks, documentation should mention that since most people re-borrow three times (as an example), the projected total cost of borrowing is $135.
This second item would emphasize the consequences of defaulting, borrowing from a second payday loan company or re-borrowing from the original lender.
Mandatory Credit Reporting
Payday loans are attractive to consumers in need of cash because they are accessible, convenient and perceived to be a temporary solution to a short-term financial problem. In truth, for most people, the use of payday loans are a symptom of a broader underlying financial crisis. That is why the people we see, end up using payday loans over and over and over again. Legislation limiting rollovers has not worked. People in a cash crisis simply visit more than one lender. In the end, they come to see us with an average of 3.5 loans outstanding at the same time, totaling over $2,700.
AFS products should be included as part of the current credit reporting system. We recommend that AFS lenders be required to:
- Report all lending activities to the major credit reporting bureaus;
- Review a person’s credit report prior to advancing funds.
Another option would be to limit the extent to which a consumer can become indebted to AFS types of loans (such as limiting the portion of their pay, which can be subject to payday loan debt) so that fewer individuals would find themselves severely indebted with multiple AFS loans. This limitation would only be enforceable, however, if payday loan and all AFS products are required to be reported on a person’s credit report.
Encompassing New Products and Services
The challenge with any legislation is to be able to stay ahead of new products as they come to market. As soon as the legislators close one gap, another opens.
Consider legislation that limited loan rollovers. Consumer found a way around this by visiting multiple lenders. Online access made this even easier. Consider as well that new products like high-risk installment loans have been introduced into the market as an ‘alternative’ to payday loans. These products may be slightly cheaper, but at 60%, many consumers are still unaware of the true impact these loans will have on their long term financial health. The addition of a simple budget calculation to lending documentation that requires a consumer to demonstrate their ability to repay the loan, without rollovers or going into default, might be helpful. In other words, AFS lenders should, like other traditional lenders, be required to consider capacity to repay before advancing funds. Given the current effective interest rate and high profitability, there is no incentive today for them to do so.
Another recent growth trend is the proliferation of ‘credit repair’ products. These are ‘loans’ which are offered to consumers for an upfront fee and at a heavy interest cost, with the promise that the lender will report payments to their credit bureau, thus enabling them to rebuild their credit sooner. These loans have no risk to the lender (they are secured against the deposit), yet charge very high interest rates, similar to credit card debt rates and higher, on top of the up-front fee. In one such instance we saw a client apply for a $1200 ‘loan’ against a savings deposit of $1,000, net of the up-front fee of $200. In the end, their interest and fee costs over three years would amount to $500 on a $1200 loan. The stated purpose of these loans is to repair bad credit, however, based on our knowledge and experience, these loans are unlikely to be successful at repairing credit. The amount of the debt is too small and the lender questionable. They are likely no more effective than a secured credit card which can be acquired at a significantly lower cost.
Any legislation changes must be written with a goal to providing protection against not just today’s products, but tomorrow’s as well.