Millions of low-credit Canadians are likely to lose access to credit due to the new criminal interest rate changes. The Government of Canada recently announced its plan to reduce the current criminal interest rate during the 2023 Federal Budget reveal.
Unfortunately, in an effort to protect Canadians from predatory lenders, the government is also limiting low-credit Canadian’s access to credit. They are also limiting small and medium sized businesses from starting and flourishing.
Why? Because people and businesses cannot go to banks all the time.
What’s Happening To The Criminal Interest Rate Charges?
The current criminal rate of interest was first implemented more than 40 years ago, in 1980, under Prime Minister Pierre Trudeau. The goal was to deter loan sharks from charging higher rates and using intimidation.
This regulation particularly helped those who are most vulnerable to predatory lending, such as seniors, newcomers, low-income Canadians and low-credit Canadians.
The law capped the legal interest rate (or made it criminal to charge more than) 60% effective annual rate (EAR) or annual percentage yield (APY). An APY calculates all fees and compounding interest and tells how much a lender makes on a loan.
In fact, a 60% EAR is a 47% annual percentage rate (APR).
The current federal government wants to bring the APR criminal interest rate down from 47% to 35% APR.
The proposed 35% APR rate is not as low as you might think.
The ugly truth is that fees apply everywhere, from your bank account to your credit card to your loan.
They also plan to reduce the interest rates payday lenders charge. Currently, payday lenders charge between $14 per $100 borrower to $25 per $100 borrowed. The Government of Canada intends to change it to $14 per $100 borrowed across Canada.
How Will Criminal Interest Rate Changes Affect Canadian Consumers?
According to the Canadian Lenders Association (CLA), the lowering of the maximum allowable interest rate from 60% APY to 35% APR will ultimately hurt millions of Canadians.
The Canadians in question are those who are often classified as subprime or credit constrained. In a press release put out by the CLA, president and CEO Gary Schwartz states that “This will disproportionately affect low-income Canadians – the segment of the population most at risk given their inability to qualify for credit at prime rates – who struggle to make ends meet by limiting or eliminating entirely their access to credit.”
While it is still too early to see how this will affect Canadian consumers in general. It’s clear that millions of Canadians, including newcomers who don’t have a Canadian credit score or credit history, rely on high-interest loans to get by.
Will Shrinking The Lending Industry Benefit Anyone?
It might benefit the credit card industry. Credit card cash advances carry high-interest rates and charge from day 1 of the transaction. Plus a payment made to your card balance might not go toward the cash advance portion. Of course, late payments or missed payments may ruin credit scores quickly.
New results from a Loans Canada’s survey found that 5.38% of people turn to their credit cards when there is a shortfall. 18.71% turn to subprime lenders and only 8.24% turn to a bank.
How much would a $5,000 loan cost from a bank, credit card, and personal loan?
| Bank | Personal Loan | Credit Card Cash Advance | |
| Loan Amount | $5,000 | $5,000 | $5,000 |
| Interest Rate (APR) | 5% | 14% | 21.99% |
| Term | 24 months | 24 months | 30 days (interest charged from day 1) |
| Monthly Payments (Principal & Interest) | $219.36 | $240.06 | $5090.36 (if principal and interest paid back after 30 days) |
| Total Interest | $264.64 | $761.44 | $90.36 (for only 1 month) |
| Total Cost | $5,264.64 | $5,761.44 | $5,090.36 |
If the consumer took the same 24 months to pay off their credit card cash advance, the interest payment balloons to $2,198, making the total cost of the cash advance loan $7,198.
How Will These Changes Affect Alternative Lenders?
The change to the criminal rate of interest will affect not only Canadians but lenders too.
Many of these high-interest lenders lend on a small scale. They are small businesses and they employ Canadians.
By reducing the criminal rate of interest, their ability to offer loans will be limited, thereby reducing their competitiveness. This will likely cause more individuals to rely on other lenders such as goeasy, which has more operating leverage.
How Will Criminal Interest Rate Changes Affect Personal Loans?
If the criminal rate of interest is reduced to 35% APR, it will likely affect personal loans in the following ways:
- It Will Have A Lower Cost – With the interest rate (APR) capped at 35% from 47%, the cost for the consumer will be significantly less.
- Fewer People Will Qualify – Lenders base loan eligibility and their interest rates on numerous factors. One of them is dependent on the borrower’s risk. Without the ability to charge higher rates for riskier borrowers, lenders will have a hard time offsetting the risk. As such, those with poor credit or finances will be less likely to qualify for personal loans.
- Less Personal Loan Options Will Be Available – With a lower criminal rate of interest, consumers may have fewer personal loan options.
How Will Criminal Interest Rate Changes Affect Business Loans?
Raising capital to start a business is tough. Most banks won’t lend to small businesses or startups. While some businesses may be lucky enough to get venture capitalists (VC) funding, others need to find other means of financing. Unfortunately, banks are not the most inclusive providers. Instead, businesses need subprime lenders who provide funding to individuals and businesses based on a wider set of criteria.
Without access to these business loans, many businesses won’t be able to get the funding necessary to start or grow their businesses.
Why Do Alternative Lenders Charge Higher Rates Than Banks To Be Profitable?
In Canada, there are banks and credit unions that charge, what most consumers would agree are, more affordable interest rates. These institutions are without a doubt profitable. In fact, banks are for-profit businesses and the Big 6 Canadian banks are listed on Canadian and international stock exchanges.
So why do alternative lenders need to charge such high-interest rates to earn a profit? Well, there are many reasons, such as operations of scale, access to affordable capital, and rate of defaults.
Banks Have Access to Cheaper Funding
Simply based on the way a bank runs, they have access to more affordable capital than alternative lenders. In general, banks are able to borrow money at a much lower rate from the Bank of Canada. Therefore, they are able to charge lower interest rates.
Banks Are Larger
Alternative lenders are often small businesses that have higher operating costs. Banks on the other hand are large and able to reduce operating costs because of their scale. This means that the administration cost associated with one loan is lower for banks. This allows banks to still earn a profit even when they charge lower interest rates.
Diversification
Again because of their scale and how banks operate, they have a large and more diversified portfolio of assets. Banks do not rely only on profits from loans. This means that they are able to maintain profit even when a loan goes into default.
Lower Default Rates
Banks have more strict lending requirements and underwriting processes. This can lead to a lower rate of default. The risk of loss because of default is therefore lower for banks than alternative lenders.
Can Alternative Lenders Be Profitable With Lower Interest Rates?
Alternative lenders can be profitable by charging an APR of 35% instead of 47%. However, it depends on multiple factors such as the lender’s default rate on loans, operating costs and consumer demand.
While lowering the criminal code of interest may make loans more affordable and increase demand, it doesn’t mean the lender will be profitable. The lender needs to ensure that the cost of delinquencies is minimized, along with all other aspects of the business (i.e operating costs).
