Capping the Cost: The Impact of Canada’s New Criminal Interest Rate Law
Effective January 1, 2025, the federal government has lowered the criminal interest rate and the maximum payday loan interest rate.? Great news for borrowers, right?? Perhaps, but I predict some unintended consequences.
Brief History
In 1980, the federal government introduced section 347(2) of the Criminal Code of Canada to set a criminal interest rate.? If a lender charged more than that interest rate, they broke the law. ?And now, 45 years later, the law has changed.
Effective January 1, 2025, the maximum interest rate a lender can charge has dropped from a 60% effective annual rate (EAR) to 35% APR.?—?(equivalent to approximately 48% on an annual percentage rate (APR)) basis to 35% APR.
Who Cares?
According to WOWA, mortgage interest rates in Ontario are well under 5.0% for most terms.? Car loan rates are in the 8% to 11% range for someone with decent credit. ?Credit card rates can be anywhere from 10% to over 20%, so why does it matter that the maximum interest rate has dropped from 48% to 35%?? Who cares?
This new law is not designed to benefit borrowers who are getting loans secured by houses, cars, or even credit card borrowers.? The proposed beneficiaries of this law change are borrowers with “bruised” credit who borrow from finance companies and payday lenders.
What About Payday Loans?
In the past, payday loans were provincially regulated.? In addition to reducing the criminal interest rate on installment loans, the maximum interest rate on a payday loan is now governed by federal legislation.
(Section 347.1 (1) and (2) of the Criminal Code defines a payday loan as a loan of $1,500 or less that will be repaid in 62 days or less).
In 2024, in Ontario, the maximum interest charged on a payday loan was $15 on every $100 borrowed.? The Criminal Code now imposes a national limit of $14 per $100.
KEY POINT: “14 on a 100” is NOT a 14% interest rate.? If you borrow $100 and pay it back in two weeks when you get paid, and then borrow it again and do that every two weeks for a year, you borrowed $100 twenty-six times and paid $14 x 26 in interest, for a total of interest costs of $364.? While the payday lenders will disagree with my math, I believe that if you have a $100 loan outstanding for a year and pay $364 in interest, the interest rate on that loan is 364%.
How will this impact borrowers?
In theory, high-risk borrowers will pay a lower interest rate.
In reality, lenders charge interest rates to compensate for the risk they take lending money.? The higher the repayment risk, the higher the interest rate.? So if a lender believes they need to charge 45% to compensate for the risk, but can only charge 35%, presumably they will reduce lending to high-risk borrowers.
Let’s analyze this concept of “lenders want to make money.”
The largest publicly traded sub-prime lender in Canada is goeasy Ltd.? For the quarter ended September 30, 2024
Net charge offs in the quarter as a percentage of average gross consumer loans receivable on an annualized basis were 9.2%, up from 8.8% in the same period of 2023, primarily due to a relatively weaker macro-economic environment and the implementation of tighter collection measures, partially moderated by an increase in the proportion of the consumer the loan portfolio secured by hard assets. ?The Company’s net charge off rate was in line with the Company’s targeted range for 2024 of 8.0% to 10.0%.
?
Their forecast for 2024:
·???????? Gross consumer loans receivable $4.6 billion
·???????? Total revenue: $1.55 billion
·???????? Total yield on consumer loans 34%
·???????? Net charge-offs: 9% ($.414 billion)
·???????? Total operating margin: 39% ($.6045 billion)
?
Let’s do some simple math: If the interest rate you can charge drops from 48% to 35%, if your loan volume remains the same, that’s a decrease in revenue of 27%.
(I’m over-simplifying because not all revenue is interest income, and they aren’t charging the maximum interest rate).
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They know their loan write-offs could be as high as 10% under their current lending practices.? If they are charging 48%, they are still making money, but if they can only charge 35%, they don’t make as much money. ?(Perhaps a drop of $300 million).
Here’s the interesting point: easygo is projecting increased loan volume and revenue in 2025 and 2026.? They know about the new rules.? Why do they expect profit to increase?
The obvious answer is that they expect to loan more, so even if the interest rate is lower, the more you lend, the more you make.
But there’s more to it than that.? There are only two ways to increase your profit: increase your revenue or decrease your expenses.
Dubious Speculation
I know that lenders want to increase their profits—that’s a given. I don’t know how they will do it when the rate they can charge decreases, but here is my dubious speculation on their possible strategies in 2025.
Lenders borrow money to lend.? Easygo borrowed $400 million US in November 2024 at an effective interest rate of 6.875% on senior unsecured notes and a further $150 million Canadian at 6.0%.? One way to increase profit is to reduce their borrowing costs.? Here’s an idea: offer savings accounts to their customers (or anyone else).? EQ Bank offers savers 3.5% on a 1-year, non-registered GIC.? If easygo offered savers 4%, and was able to borrow $500 million, they are saving at least $10 million a year in interest costs (less the costs of administering the savings accounts).
Another obvious cost-saving strategy would be to reduce “bricks and mortar” locations.? All lenders are already doing that with phone apps.
Taking it a step further, why not use AI to make lending decisions, and to analyze customer loan applications for possible fraud?? AI can also assist with the collection process (a robot phones you when your loan is past due).? This isn’t the future; it’s already happening, but I expect it to accelerate in 2025.
Revenue Enhancement
But you can only cut expenses so much.? To grow, you need to increase revenue, and here are my top three predictions for how they will do that:
First, different types of loans.? Instead of just lending to the average working Canadian, why not offer “micro small business loans” to self-employed contractors or small businesses?
Second, offer additional services, like insurance products (loan protection and health insurance).? Many already do this, and the law does have provisions to curb this, but we’ll see what happens.? Many other services could be offered.? How about bill payment services, payment processing for small businesses, prepaid debit cards, foreign currency exchange, storage locker rentals, safety deposit boxes, rent-to-own and lease-to-buy programs, and even investment products (to go along with their new savings accounts).
Different types of loans and additional services are not radical suggestions, so here’s my top, crazy prediction for 2025:
Payday lenders and subprime finance companies will start offering memberships. ?Goeasy has 1.5 million active customers; how many would buy a membership?? If 10% of 1.5 million customers paid $10/month, that’s $18 million in extra revenue at virtually no cost (since it’s an app).? They could call it the Easy Club.
You need a membership to buy stuff at Costco. Why not do the same in the lending world?
This is entirely dubious speculation on my part, but why not charge customers $25 per month for an Executive Membership at ABC Lending?? For your $25 per month, you get an app on your phone, and you get:
Of course, I’m making this up, but why not?
My intention is not to give all the subprime and payday lenders ideas on how to make more money from you. They are way smarter than me, and they’ve already got teams of people working on this; they don’t need my help.
The point is to give you a “heads-up” on the marketing push you will be subjected to so you can recognize it as it happens and be prepared to respond.
Some of the deals might be great.
Most deals will probably cost you more money than you need to spend.
Do you want to pay a monthly fee at a payday lender?
Lenders will want to replace their lost revenue, so they will try a few new tricks.? As a borrower, you should know these new tricks and prepare yourself for them.
Protect yourself!
Ted and I discussed this in detail on this week’s Debt Free in 30 Podcast; enjoy!