What happens to Canadians who can’t repay their payday loans? Today, I will explain what steps to take if your payday loan is in collections.

What happens if you don’t pay back your payday loan?

Failing to repay your payday loan will make your financial situation worse and can have severe consequences, including:

Collection calls: If you don’t pay your payday loan, it can be sent to a collection agency, subjecting you and your references to collection calls from debt collectors. Once a payday loan is in collection, it will appear as a negative item on your credit report.

A second attempt to collect from your bank account: Payday lenders typically have you sign a pre-authorized debit against your bank account with the amount due when or shortly after you receive your next paycheque. Depending on the province, the lender might retry an automatic payment if there was not enough money in your account to repay the loan the first time. Some provinces do not allow repeat payment processing (Ontario), while others limit processing attempts to two.

Additional fees and interest costs: You will face additional fees from your payday lender at a very high interest rate on your outstanding balance. This further increases the cost of borrowing in an already financially strained situation. In Ontario, regulations governing late fees from payday lenders cap the maximum interest rate at 2.5% per month on the balance due. If you owe $1,200 on a payday loan, that is an additional $30 in interest costs the first month, increasing from there as interest charges compound.

Bounced payment charges: Both your payday lender and financial institution will charge an insufficient fund (NSF) fee for a bounced payment unless you have overdraft protection. Ontario law limits bounced fees from payday lenders to $25 per missed payment.

Potential lawsuit: While a collection lawsuit from a payday lender is rare, it remains a possibility, with potential consequences including the seizure of funds from your bank account or a wage garnishment in which they may contact your employer.

Harm your credit score: Ultimately, missed, late, or non-payments on your payday loan can severely harm your credit score, creating long-lasting repercussions for your financial health.

Strategies for dealing with payday loans in collection

When dealing with payday loan collections, knowing your rights and having a plan for communicating with debt collectors is important.

Familiarize yourself with what debt collectors can and cannot do. In Ontario, for example, collection agencies must notify you by letter or email before they can contact you to collect. They can contact you by phone or text on a Sunday between 1 p.m. and 5 p.m. local time and on a Monday to Saturday between 7 a.m. and 9 p.m.

If you speak with a debt collector, remain calm and professional. If they threaten or bully you, hang up and consider reporting them for harassment.

If you negotiate a payment agreement, document everything and get any repayment plan or settlement in writing before making any payments.

The debt collector may accept a debt settlement if you can’t pay the full amount.

If you cannot come to an agreement or the amount is more than you can afford to repay, consider options like a consumer proposal or bankruptcy.

Once you have paid off a payday loan, avoid payday loans in the future by considering alternatives to payday loans, including taking out a small loan from a credit union, getting a cash advance on your credit card, borrowing from friends or family and finding ways to reduce expenses so you can build a small emergency fund.

FAQs about payday loan collection

Let’s take a look at some of the most frequently asked questions regarding collections and payday lending.

Do payday loans show up on a credit report?

Payday lenders usually do not report payday loan activity to the credit bureaus, but they do report installnent loans or lines of credits. Since payday loans typically do not appear on your credit report, borrowing a payday loan is unlikely to affect your credit score. If you default on a payday loan and it is assigned to a third party collection agency, the collection account will be reported to TransUnion or Equifax, negatively impacting your credit rating.

Can payday loan lenders take you to court in Canada?

In Canada, payday loan lenders have the legal right to take borrowers to court, garnish wages or seize personal property if they default on the loan. While the decision to pursue legal action varies among lenders, some payday loan lenders may choose to sue you in small claims court to recover the debt.

It’s important to note that each province in Canada has laws and regulations regarding payday loans and debt collection. The Limitations Act outlines the time frame for creditors to pursue legal action to collect unsecured debts – two years in Ontario.

In Ontario, payday lenders must be licensed and follow the rules of the Payday Loans Act. Debt collectors must be registered under the Collection and Debt Settlement Services Act.

Can payday loans contact your employer?

A payday lender can contact your employer to confirm your employment but cannot tell anyone you owe money, which means they cannot contact your employer, friends or family to try to collect.

If the payday lender obtains a garnishment order, they can contact your employer to withhold money from your paycheque and direct it to the lender.

Can a payday lender take money from my bank account without my consent?

In Canada, payday lenders are generally not allowed to withdraw funds directly from your bank account without your consent or a court order. However, some payday loan agreements may include a voluntary wage assignment clause where you permit the lender to garnish your wages to repay the loan if you default. You can rescind this permission anytime if you signed such a clause with a payday lender.

Can you go to jail for a payday loan?

You cannot go to jail for defaulting on a payday loan. While payday lenders may take legal action to recover the debt, such as suing you in court, defaulting on a payday loan is not a criminal offence in Canada.

Can I delay or extend a payday loan?

Payday loans are typically short-term loans, although you may have up to 62 days to pay them back, depending on your loan agreement.

In most provinces in Canada, payday loan rollovers, also known as loan extensions or renewals, are not allowed by law. You cannot delay a payday loan by rolling it over with the same payday lender.

Some provinces in Canada have rules regarding successive payday loans. For example, if you have taken three loans within 63 days in Ontario, the payday lender must offer you an extended payment plan.

Can I take out a loan with another payday lender?

While you can’t get another payday loan from the same lender, nothing stops you from taking out a loan with another payday lender, either in person or online.

Taking out a loan with another payday lender to cover an existing debt is unwise and leads to a payday loan cycle that is difficult to break. Owing money on multiple payday loans often leads to bankruptcy.

Should I use my credit card to pay off my payday loan?

Most people who take out a payday loan have done so because they no longer have any available credit limit on their credit cards. However, credit cards charge a much lower annual interest rate than a payday loan. If you can refinance your payday loan with your credit card, paying less interest might make sense and help you repay the loan amount sooner.

Taking a cash advance on your credit card to pay off a payday loan will result in cash advance fees and increase your credit card debt. Make sure you have a repayment plan for your credit card bill so you don’t end up reborrowing from the payday loan company and end up in a payday loan cycle of debt.

Can you do debt consolidation on payday loans?

You can consolidate payday loans if you have enough good credit to qualify for a new debt consolidation loan.

Taking out a line of credit or personal loan from a bank or credit union to pay off a payday loan can be a good idea due to the lower interest rates of these types of loans.

By consolidating high-cost payday loan debt into a lower-interest loan, you can save money on interest payments, lower your monthly payment and pay off your total debt balances faster.

The key, however, is to ensure that your consolidation loan has a low interest rate and that you can afford the monthly payments. Many payday lenders now offer high-interest lines of credit. We do not recommend these loans due to the high cost of borrowing.

Another option is to talk to a credit counselling agency about doing a debt management plan. Not all payday lenders will agree to repayment through a DMP, but this is worth exploring if you only have a small amount of payday loan debt.

You can also consider filing a consumer proposal if you struggle with high payday loan debt and other unsecured debt like credit cards, lines of credit, tax debts or student loans.

Can I file bankruptcy for payday loans in Canada?

Yes, Canadians can file for bankruptcy to deal with payday loan debt. Bankruptcy is a legal process allowing individuals to discharge most of their debts, including payday loans, providing a fresh financial start.

Seeking advice from a licensed insolvency trustee can help you understand your options for debt relief regarding bankruptcy or alternative solutions such as a consumer proposal.

How to get out of payday loan debt

If you have payday loans in collection and find you can’t pay back your payday loans, you have options for payday loan debt relief.

Reach out to one of our licensed insolvency trustees for a free consultation. We will help you develop a strategy to deal with high-interest payday loan debt.

Know that you are not alone in your struggle. More than 40% of our clients have at least one payday loan, and most have multiple payday loans. (ask sharon about this) – significant instead of number.

Our team will review your financial situation, look at your budget and help you create a path towards becoming debt-free.

You can break free from the payday loan trap and regain control over your finances by exploring your options.

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We first wrote about the problem with unregulated debt consultants back in 2011. Our stronger fight against unlicensed debt advisors dates back to 2017 when Ted Michalos and I first discussed the issue on our Debt Free in 30 podcast. Fast forward to 2018, when a guest shared a personal story of being scammed by these individuals. Despite efforts to shed light on the problem, these consultants persist, as highlighted in a recent interview I did in November with Pat Foran from CTV News.

Why the Fight Against Unlicensed Debt Consultants Matters

Debt consultants levy a fee for their advice, a practice common in many professions. However, the crucial distinction lies in their need for more expertise in insolvency. 

In Canada, only a Licensed Insolvency Trustee possesses the authority to file a bankruptcy or consumer proposal on behalf of consumers. This exclusive designation requires that Licensed Insolvency Trustees hold in-depth knowledge of the process and have a documented history of successfully guiding individuals through insolvency. The examination and accreditation process to become a Licensed Insolvency Trustee is quite onerous and the obligations of a Trustee are regulated by the Office of the Superintendent of Bankruptcy.

In contrast, these debt consultants do not have the experience to assess your situation correctly. It’s like talking with your neighbour or co-worker about whether you should file a consumer proposal because they read something about it and know all the right words. The people you talk with on the phone are trained in selling consumer proposals but have no real experience when it comes to getting consumer proposals filed or approved. They also have no verified training or knowledge of The Bankruptcy & Insolvency Act which outlines the rules and regulations for consumer proposals.

Would you pay some unlicensed stranger to give you medical advice if you are sick? No, you would not. So why pay some salesperson to sell you their ‘help’ collecting information to send you to a Licensed Insolvency Trustee?

A Conversation with the Superintendent of Bankruptcy

On September 12, 2023, while attending a conference I had a quick chat with the Superintendent of Bankruptcy, Elisabeth Lang. She assured me that her team had diligently worked on the issue and promised imminent action. True to her word, on December 7, 2023, she published a comprehensive position paper titled “The Adverse Effects of the Debt Advisory Marketplace on the Insolvency System.”

The paper dissects the problems including:

• the deceptive portrayal of unlicensed consultants as licensed and qualified professionals in advertising and in practice,
• the solicitation of consumers into insolvency who perhaps should not be filing but pursing other options (which a Licensed Insolvency Trustee is required by law to disclose),
• potentially higher proposal payments and certainly extra debt consultant payments, amounts which result in an additional cost to the consumer and potential loss to his or her creditors.

Over the last two years, consumers have fallen victim to these dubious consultants, paying a staggering $21 million in fees. Shockingly, in 2022 alone, debtors committed to paying $7.6 million in fees after filing their proposals. Imagine paying a “medical consultant” a hefty fee after the surgery is complete—outrageous!

Superintendent Lang asserts her commitment to addressing non-compliance, including the consideration of licensing measures, civil, and criminal proceedings. A bold move, but will it be effective?

What Would I Do if I Were the Superintendent of Bankruptcy?

First, I would gather all the data on these offenders and their not-so-legal practices.

Next, I would speak with the senior Licensed Insolvency Trustees from the offending firms in private one-on-one meetings. No beating around the bush. I would give them fair warning to clean up their practices and say, “This ends now.” Ms. Lang might have done the same; I can’t confirm, but I am hopeful that that was her first action in her attempt to eliminate this egregious practice.

After “playing nice”, I would take a more direct approach. I would not bother with investigations (since I already have the data to know what’s happening)or legal battles.

Instead, I would use some bureaucratic tricks. I would “gum up the works.” A trustee needs a Letter of Comment from the Office of the Superintendent of Bankruptcy (OSB) to get paid. These comment letters are issued quickly and automatically, but the OSB could decide to do a manual review, which slows down the process and results in slowing down the trustee’s cash flow. If they want their cash flow to speed up, they will be forced to do the right thing. Simple as that.

I would also request creditor meetings and debtor examinations on files of firms suspected of working with debt consultants. Creditor meetings are rare but effective in stirring the pot as they can be quite time intensive. If a trustee dedicates an hour to a hundred creditor’s meetings convened by the OSB each month, their schedule would be overwhelmed, leaving little time for other tasks. That would significantly impede their workflow.

The OSB could also ask debtors what they paid prior to filing a consumer proposal. Most of them might not know upfront fees are not legally part of their consumer proposal. If debtor’s understood that they paid unnecessary fees, they could demand refunds, and demanding refunds could spread the word and may force the debt consultants (and the offending trustees) out of business.

Finally, while I blame Licensed Insolvency Trustees for teaming up with these crooks and the OSB for not dealing with this issue sooner, I also blame the large creditors for allowing this to happen. If you’re aware that debtors are tapping into credit card advances to pay these consultants, it’s time to rethink your voting process. Instead of voting for inappropriate proposals, they should vote to reject them, which puts both the trustee and the debt consultant out of business.

(I have discussed the “vote no” approach with the major creditors in Canada, and while they understand the issue, they are reluctant to “punish” a debtor by voting against the proposal when the debtor perhaps was unwilling duped by the debt consultant).

Avoid Debt Relief Scams

For consumers wondering how to avoid debt relief scams, here are some recommendations to ensure you don’t become the next victim.

Check if the person or company you’re talking to is a Licensed Insolvency Trustee. If you need more clarification, look them up on the OSB list of Licensed Insolvency Trustees.

Only sign agreements that ask for payments after you meet with a Licensed Insolvency Trustee, sign proposal documents, and have them filed with the government.

Ask the person you’re dealing with about their charges. You shouldn’t have to pay someone to help with the process or prepare paperwork for a consumer proposal. If you’re unsure, get a second opinion from another Licensed Insolvency Trustee. Reputable firms provide free consultations and request payment only after your proposal is officially filed.

Be concerned if the company you originally contacted, or person you speak with about your debt situation, works for a company that is different that the company you file your consumer proposal with. This is a glaring warning sign that you have been scammed with additional fees. Seek advice immediately, before filing your consumer proposal, with another Licensed Insolvency Trustee to ensure the proposal you are entering into is fair and necessary.

Looking Ahead

How will this play out? Although Ms. Lang’s position paper is a positive initial step, my past experiences indicate that government position papers often fall short of actual action and can be seen as a mere substitute for tangible measures. Nevertheless, this could mark the beginning of real change.

The unfolding events remain uncertain, and only time will reveal the outcome. Let’s hope today signifies the commencement of resolving this predicament for Canadian debtors. Stay tuned for further updates and valuable insights on the Debt Free in 30 podcast.

The post Will the Federal Government Finally Put an End to Unregulated, Unlicensed Debt Consultants? appeared first on Hoyes, Michalos & Associates Inc..

Why might someone need an emergency loan? We will look at the pros and cons of using payday loans for emergencies, their associated interest rates, and late fees, and most importantly, explore better alternatives to address these unexpected financial challenges we face in Canada.

Pros and cons of using a payday loan for emergencies

Let’s start off with learning about emergency loans. An emergency loan is a short-term personal loan that you may seek when confronted with unexpected or urgent expenses. These expenses include medical bills, car repairs, unexpected home repairs or other unforeseen financial crises. Even vet bills can take a toll on your bank account. I bet you were not expecting to wake up to a flooded basement or a sick puppy and in these cases, you may need to look into borrowing money. The critical characteristic of an emergency loan is its swift availability to help address these immediate needs.

While emergency loans themselves are not inherently bad, the source of the loan matters significantly. Turning to payday loans for emergencies can often be a bad idea due to their exorbitant interest rates and associated fees. They can even lead to poor credit if you don’t pay them back by their due date. There are better alternatives that can help you navigate through financial emergencies without falling into a debt trap.

Pros of payday loans:

Payday loans may work for certain individuals when it comes to using them for emergencies. What are the pros to payday loans?

• Quick access: Payday loans are readily available, often with minimal credit checks.
• Immediate relief: They can provide same-day cash to cover urgent expenses.

Unfortunately, for those living in a low-income household or those already dealing with debt, the cons outweigh the pros. 

Cons of payday loans:

• High annual interest rates: Payday loans come with astronomical interest rates, often exceeding 360% APR.
• Short repayment period: Borrowers are typically required to repay the loan in full on their next payday, which can be challenging.
• The cycle of debt: Many borrowers find themselves trapped in a cycle of borrowing to cover previous loans, leading to a never-ending cycle of debt.
• Hidden fees: Additional fees can quickly escalate the cost of the loan.
• Payday lenders can be very aggressive when it comes to collection. Some lenders require their borrowers to sign a form called a “Voluntary Wage Assignment” which allows the borrower’s wages to be garnisheed if they do not repay the loan as agreed. This gives the payday lenders easy access to garnish your wages if you are not making you payments.

You unfortunately can’t ask your employer to stop a voluntary wage assignment and it can be a symptom of a greater financial problem if you have received a legal garnishment order. There are however options to stop a wage garnishment.

The costs associated with payday loans are staggering. A typical payday loan might carry an APR of 360% or more! This means that if you borrow $500 for two weeks, you could owe $570 in just two weeks, an exorbitant amount compared to the initial loan. These high fees make payday loans an unsustainable option for emergency funding.

Alternatives to a high-interest emergency payday loan

There are some alternatives and different types of loans you can consider when it comes to high interest emergency payday loans.

Emergency Savings Fund: Building an emergency fund in a checking account is the best way to prepare for unexpected expenses. Saving even a small amount regularly can provide a financial cushion during emergencies. While we understand that it may not always be feasible, it’s worth considering if you happen to have surplus funds. Whether it’s a work bonus, money received during the holidays, or on your birthday, saving such windfalls could be beneficial in unexpected emergencies.

Credit Union or Personal Loans: Credit unions often offer more affordable short-term loans to their members. Personal loans from banks or online lenders also provide better interest rates compared to payday loans.

Credit Card: If you have a credit card with available credit, it can be used to cover emergency expenses. While credit cards may have high-interest rates, they are usually lower than payday loan rates. Always be aware before you swipe. A high credit card balance can also lead to poor credit and the annual interest rates can be extreme and hard to pay off.

Family and Friends: Consider borrowing from friends or family members who may offer you a small loan with more favorable terms and without the pressure of immediate repayment. 

Negotiate with Creditors: In most cases your lenders will understand. Try negotiating and asking if you can pay half of your debt with your next paycheck or ask to see if you can compromise on a repayment plan. Don’t be afraid to ask for an extension or if they will waive the late payment fee if it doesn’t affect your credit score.

Learn more about alternatives to payday loans for emergencies and other options you can consider if you are running short on cash and to help your financial situation.

How to avoid the payday loan trap

Breaking free from the payday loan cycle and avoiding the debt trap is crucial. Here are some steps to help you stay financially stable:

Create a Budget: Create a realistic budget that accounts for your living expenses and savings. Stick to it diligently to avoid overspending. Now if you read my book “Straight Talk on Your Money,” you will probably question this advice because I think budgeting is a bad idea. I suggest sticking to a system where you can easily manage your money.

Start an Emergency Fund: Just like we stated above, saving for an emergency fund is always a good idea. Build and maintain an emergency fund in a savings account with at least three to six months’ living expenses. Again, we realize this is only sometimes an option for everyone.

Avoid Living Paycheque to Paycheque: Look for ways to reduce your living expenses and increase your income to break the cycle of living paycheque to paycheque.

Improve your Credit Score: Improving your credit score over time will help you access more favourable borrowing options.

In summary, I sincerely urge you not to use a payday loan for emergencies. It’s very likely that you’ll regret it, and it could seriously mess up your finances and credit report. While emergency expenses can be daunting, resorting to payday loans, especially for those with bad credit, should be your last resort. Their high costs trap you into a debt cycle, making them a detrimental choice for handling financial emergencies.

Instead, focus on building financial resilience through savings, responsible borrowing, and long-term financial planning to ensure you’re prepared for whatever life throws your way. Remember, there are better alternatives that can help you weather the storm without drowning in debt. Payday loans may provide quick cash, but they are not worth the high cost and damage to your financial well-being.

If you’re facing difficulties and caught in the repetitive payday loan cycle and payday loan providers are closely pursuing you, don’t hesitate to contact one of our Trustees for a free consultation. We’re here to assist you in breaking free from the debt cycle. In the meantime, you can learn more about your options. Check out our customer testimonials from individuals we’ve assisted in becoming debt-free. No matter the financial difficulties you face, the Hoyes Michalos’ family is here to help get you back on track!

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But as convenient as revolving credit is, it can be risky if you are not careful. Read on to learn about how revolving credit works, its benefits, how much you should have, and its connection to your credit score.

How does revolving credit work?

Simply put, revolving credit is credit that you can use, pay back down, and then use again. Hence why it’s called revolving. If your credit application is approved, your lender gives you access to borrow up to a certain credit limit on different credit products such as a credit card or line of credit. It is credit that is continuously available to you as long as your bank does not cancel your card or credit line. This differs from credit like a car loan which you pay down and once paid off you no longer have access to borrow any more funds without reapplying for new credit.

Revolving credit doesn’t become debt until you borrow from it. For example, you may have a credit card with a $2,000 limit. If you don’t use it to pay for anything, then your balance remains $0 and you have no debt. But let’s say you used your credit card to buy something for $200, you would then owe $200 on your credit card by the payment due date.

The cost of using revolving credit varies by the credit type. For example, credit cards give you a no-interest grace period. If you pay your credit card balance in full by the due date, you won’t get charged interest on what you borrowed. A line of credit, on the other hand, typically charges interest from the day you borrow until you pay the balance back in full.

Types of revolving credit

There are three types of revolving credit accounts: credit cards, unsecured lines of credit, and secured lines of credit like a home equity line of credit (HELOC).

Credit cards

There are two types of credit cards: secured and unsecured. They are both revolving credit accounts.

Secured credit cards are special because they require an upfront deposit. One of the main advantages of a secured credit card is to help individuals with low credit rebuild a healthier payment history. With a secured credit card, your cash deposit becomes your credit limit. For example, if you put in $500 on deposit with your secured card provider, you will have a $500 limit on the card. Your deposit becomes the lender’s insurance in case you start defaulting on payments. Note that with a secured card, any purchases you make will still need to be repaid because your deposit on the card is not the money you are spending. It’s the lender’s collateral. So, if you buy something for $20 on a secured credit card, you will still need to repay that $20 by the payment due date. Interest rates on secured cards typically range from 19% to 25%. Aside from the deposit component, you can use a secured credit card just like a regular, unsecured credit card. By making full and timely payments, you can build a better credit score over time.

Unsecured credit cards don’t require a deposit and have limits that can range from $1,000 to $10,000+. Your bank will assess your credit health and determine the credit limit they will let you have on an unsecured card. Low interest cards are available for those with prime credit, but most regular unsecured credit cards typically carry interest rates of 19% to 29%. They may also come with annual fees. Some credit cards may also offer you rewards like air miles or cashback on purchases you make.

Unsecured lines of credit

An unsecured or personal line of credit is a revolving line of credit with a set limit. Again, your bank will approve your credit limit based on your creditworthiness. Interest rates on unsecured lines of credit can range from 6% to 14% from a main bank or credit union.  Lines of credit often charge a variable interest rate, meaning it could change at the lender’s discretion.

When you borrow from a line of credit, the interest charges start right away, and you will be charged on the money you borrow until you pay your balance in full. There is no grace-period like with a credit card.

There are also personal lines of credit offered by rapid loan lenders, charging interest rates of 45% or higher. These lines of credit are targeted at individuals with low credit who otherwise won’t qualify at a bank. We caution against borrowing loans or lines of credit from these high-cost lenders because it can lead to serious debt problems. Repaying your balances in full becomes an impossible task because of the higher interest rates and added fees these lenders charge.

Secured line of credit

The most common example of a secured line of credit is a home equity line of credit (HELOC), which is secured against the equity in your home. Lenders allow you to borrow up to 80% of your home’s value as a revolving credit line. HELOCs generally have variable interest rates based on the lender’s prime rate.

Like unsecured lines of credit, interest charges start on anything you borrow on a HELOC from the first day until you pay off your balance in full. The biggest risk with borrowing from a HELOC is that it is secured against your home. You may risk losing your home if you borrow more than you can repay.

HELOCs are also a callable debt, which means your lender can change the rules and conditions whenever they want to. For example, your lender may require you to repay your whole balance at once. This can be a shock to your finances and a risk to your home if you are not ready.

What is non-revolving credit?

Non-revolving credit is a product that you cannot continuously borrow from and repay. Non-revolving credit is also known as an installment loan. For example, a student loan, personal loan, auto loan, or a mortgage are all non-revolving credit products. These loans typically have set monthly payments. Once you pay off non-revolving credit, you no longer carry that debt.

How much revolving credit should you have?

One of the most common questions people ask is how much revolving credit they should have access to. From our experience, you should only have access to the amount of credit you could comfortably repay in full if you were to ever borrow the maximum amount. You may from time to time receive an offer for a pre-approved credit limit increase but while these are tempting, we recommend only having access to the available credit you actually need. This is to prevent getting into too much debt and risking your financial health.

There is also a relationship between how you use revolving credit and your credit score. Credit utilization is the second largest item in your credit score calculation. Your credit utilization ratio is the percentage of total credit you borrow from the total credit room you have available (including all lines of credit and credit cards). It is recommended that you use only 30% of your total available credit room every month to maintain a healthy credit score and to show your lender that you can manage credit responsibly. If you are regularly reaching the maximum limit, this will have a negative impact on your credit score. Carrying too much debt can also lower your chances of qualifying for a loan at a good interest rate or having your loan application rejected by your bank altogether.

What are the benefits and risks to revolving credit?

The key benefits to revolving credit include access to credit whenever you need it, and the ability to build and maintain a positive credit history to qualify for lower interest rates on personal loans or a mortgage.

The main risk to revolving credit is taking on more debt than you can repay. Luckily, you can avoid debt problems by always repaying what you borrow in full every month. You should also avoid making only the minimum payments on credit cards or lines of credit because that will keep you indebted forever.

Summary

It’s important to understand how revolving credit products work because they are some of the most common and important tools we use to manage our personal finances. When used responsibly, they can allow us to build a strong credit report to qualify for other important loans like a car loan or mortgage. Unfortunately, revolving credit can also get out of hand quickly leading to debt problems.

If you feel you owe too much on your credit cards or lines of credit and you’re struggling to repay your balances or only making the minimum payments, don’t hesitate to contact us for a free consultation to review your situation and discuss relief options.

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For some indebted households, increases in the Bank of Canada have had a devastating impact on their budget. 

How much does a 25-basis point increase in interest rates cost?

Every time the Bank of Canada raises rates, banks and mortgage companies follow with increased mortgage rates. Here is the impact of a 25-point increase on a small mortgage.

If you have a $400,000 mortgage, amortized over 25 years, at 2.59%, your monthly mortgage payment would be $1,810 per month.

That same $400,000 mortgage at 2.84% would cost you $1,860 per month.

That’s an increase in your monthly mortgage payment of $50 a month.

Multiply this by the 5 rate increases some economists are predicting, and you are facing a possible increase in your mortgage payment of $250 a month.

With so many Canadians living paycheque to paycheque, this is going to be a shock. Yet, we shouldn’t be surprised.

In 2012, I was interviewed on CBC Radio’s The Current, on a segment about Doubting Personal Debt and we discussed, even way back then, that debt is a “ticking time bomb”.  Back then I warned that low interest rates were making our debt artificially ‘affordable’.  I made the comment that we could be in trouble if interest rates rise.

And on the same day in October 2018 as the Bank of Canada increased rates to the highest since December 2008, I was once again on CBC Radio’s The Current to talk about Canadian debt as part of a special they were calling Debt Nation.

When facing a rising rate environment, you need to consider what an increase in interest rates will do to your personal cash flow.

For many years the best decision a Canadian could make was to get a variable rate mortgage (not a fixed rate), because the rate was lower. That’s great, but a variable rate, obviously, is variable, so it can go down, but it can also go up.

Today you may be paying 3% on your variable rate mortgage, so on a $200,000 mortgage amortized over 25 years you are making a monthly payment of $946.40. What happens if your variable interest rate were to increase by 1%? Again, you may not think 1% is a big number, but a 4% interest rate on your $200,000 mortgage amortized over 25 years would cost you $1,052.04 per month. Can you afford to pay an extra $105.55 per month on your mortgage? Will your after-tax paycheque be increasing by $105 per month this year? If not, higher interest rates will squeeze your budget.

Here’s where most people miss the point: going from a 3% to a 4% interest rate is not an increase of 1% in your payments. If your rent goes from $300 to $400 per month, how much did your rent increase? Answer: one third, or over 33%.

That’s the point: if your interest rate increases by 1%, the actual interest cost of your mortgage in the example above increased by over 33%.

That’s a huge increase, and unless your pay will also be going up by 33%, higher interest rates will be a problem for your monthly cash flow.

How higher interest rates affect different loans

Will my mortgage rate increase?

If you have a variable-rate or adjustable-rate mortgage, the answer is yes. Your mortgage lender will increase your borrowing rate. Whether your monthly payment increases will depend on the terms of your variable rate loan. If you have a fixed payment for the remainder of the current term of your mortgage (not to be confused with a fixed interest rate) your payment may stay the same, but the amount of your payment that goes towards interest, rather than principal, will increase. This can be very costly. Not only are you paying more interest while rates are higher, but you’ll also pay more interest over the remaining life of your mortgage. Paying less principal now, means you have more principal on which the bank can charge you interest this month, next month and the month after.

Mortgage term – a mortgage term is the length of time in which the conditions of your mortgage, like your interest rate and amortization period, don’t change. For example, your mortgage term may renew in five years.

Mortgage amortization period – is the time period it will take to repay your mortgage in full, under the current conditions of your mortgage term. The amortization period is used, in combination with your interest rate, to determine your payment. For example, your payments may be based on a 25-year amortization period.

If you have a fixed-rate mortgage, the terms of your loan mean that your interest rate remains unchanged for the remainder of the term. That means that your interest rate, and payments, won’t immediately increase when interest rates rise. You will, however, be facing higher rates on renewal.

What happens to my Home Equity Loan (HELOC) or Line of Credit?

If you have a home equity line of credit or unsecured line of credit, you will see an immediate increase in both your interest rate and monthly minimum payment. Many people are shocked to hear that their financial institution can change the rate on their variable rate lines of credit overnight however those are the rules under the loan agreement.

What about fixed-term loans like my car loan?

Term loans have set loan conditions, including your interest rate, for the life of the loan. So if you purchased a car with a six-year car loan, your rate, and monthly payment will remain unchanged even as interest rates rise. However, if you refinance after buying a new car, or enter into a new lease, you will be purchasing during a period of higher rates.

What happens to my student loans when rates rise?

Again, this depends on whether your student loan is a fixed-rate or variable-rate loan. If you have a fixed rate student loan, whether private or government guaranteed, you won’t see an immediate increase in your monthly payment or interest costs. If you have a variable-rate loan, both your interest rate and minimum payment will rise.

Will my credit card rate increase?

Most people we work with have a fixed-rate, high interest, credit card with a typical rate in the 19-22% range. Rates on these types of cards do not typically change when interest rates rise. Just like they don’t decline during periods of low rates.  If you have a variable-rate card, however, your rate will increase. The best way to avoid interest charges on credit cards, no matter what rates do, is to pay your balance in full each month.

What should you do when interest rates rise?

Now is the time to make a plan to deal with your debts before your borrowing costs become more than you can handle.

Your goal in a rising rate environment should be to reduce your debt as much as possible and have a strategy of shifting debt to lower rate loans.

Here are some steps you can take to reduce the impact of rising rates on your monthly budget:

1. Make a list of your debts, how much you owe, their current interest rate and type of loan (variable rate, fixed, mortgage, credit card)
2. Focus on paying down high interest debt first. Even if the interest rate on your line of credit may increase from say 2.45% to 2.70%, if you are paying 29% on credit card balances it still makes sense to pay down your credit card debt first.
3. If you have no high interest debts, pay down variable rate debt next to avoid further increases to your borrowing costs.
4. Explore switching from a variable-rate to a locked in fixed-rate mortgage or loan to create some certainty regarding your financial payments. Talk with your lender or a mortgage broker to see what kind of rates you can refinance at but don’t forget to factor in any penalty. Know that, in a rising rate environment, variable rate loans are riskier.
5. Consider shortening the amortization period on your mortgage to pay it off sooner or switching from monthly to bi-weekly or weekly payments to accelerate your payments and become mortgage free faster.
6. If you have more debts than you can afford, particularly unsecured debt like credit cards, payday loans or older student loans, consider talking with a Licensed Insolvency Trustee about options to reduce that debt and its impact on your finances.

I can’t predict the future, so I don’t know how much more interest rates will rise but it’s likely we are facing down a few more increases over the coming months. I can, however, advise you to consider all options so that you are prepared regardless of what happens to interest rates.

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The ability to make extra repayments on a loan depends on the type of debt you carry and your loan agreement. While some term loans may come with penalties for early payment, others allow for extra payments, so you escape debt early. And of course, revolving credit like credit cards and lines of credit can be paid down as fast as you are able.

Benefits of making extra loan payments

There are two monetary benefits to making extra loan payments: saving on interest and shortening the loan term, which means you get out of debt sooner.

To understand how extra payments work, let’s look at how loan amortization works.

Each month, part of your payment goes towards interest, and the remainder goes towards the principal. When your loan is new, more of your monthly payments pay interest, and less goes towards the principal. Over time, the amount going towards principal increases and the amount allocated to interest decreases.

Loans with a fixed monthly payment, like your mortgage, car loan or student loan, work like this. This image shows how your payment amount is allocated between interest and principal over the life of a loan.

You save money on interest

Making an additional payment on a loan today reduces all future interest costs on that loan. That’s because 100% of your extra payment reduces the remaining loan balance right away.

On-going interest is calculated based on the principal outstanding on your loan. While interest rates are usually quoted annually, your lender might charge you interest compounded monthly, daily or semi-annually. However, for simplicity’s sake, let’s assume your loan interest is compounded monthly. This is the way most term loans work.

To calculate the interest you will be charged next month, divide your interest rate by 12 (the number of months in the year) and multiply by the loan amount owing at the beginning of the month. The lower your principal at the beginning of the month, the lower your interest cost will be.

When you put extra money towards your loan principal, the amount of interest you pay is lower every following month until the end of the loan term. The earlier you make additional payments, the bigger the savings. That’s the power of using compounding interest in your favour when you have debt – interest savings grow over time.

You get out of debt sooner

Making extra payments on the loan not only saves you interest, it also shortens your overall loan term, so you pay off your debt early.

Even better, the impact of one extra payment is more than one month shorter on your loan. Since your future monthly interest costs will be lower, more of each future loan payment will pay down your loan.  That’s why some lenders call their prepayment program accelerating your loan payments.

In our $40,000 term loan example, one single extra payment made in year one chops two months off your loan term. 

If you make one extra payment a year, it takes just eight payments to pay off your loan 14 months sooner. Make one additional payment every year, and it takes 106 payments to be debt free, rather than the original 120. That’s extra money in your pocket, not your lender’s.

Watch out for prepayment penalties

Even if you have the money to make an additional payment on your mortgage or loan, you may not be able to. Lenders make money by charging you interest. They don’t like you to pay off your debt faster. A prepayment penalty is a condition in your loan agreement that says if you pay off the loan in full before the maturity date, there is a penalty to compensate the lender for lost interest.

Prepayment rights are in the fine print of your loan contract. For example, you may be allowed to make two extra payments a year on your mortgage or make a lump sum or balloon payment once a year. Amounts beyond that can trigger a penalty. Read your contract carefully and weigh the costs of this penalty against future interest savings.

Pay off high-interest debt first

If you have multiple loans, always focus on reducing high-cost debt first. Some experts advocate for the debt snowball method where you knock off small debts first, but I recommend you pay off high-interest debt first. You want to accelerate the downward slope of the interest line as fast as you can; high interest rates compound your savings faster than low rates.

Personal loans vs credit cards

We talked about concepts like prepayment privileges and penalties in your loan contract. This is true for a personal loan like your mortgage or bank loan, but not revolving credit like credit cards or lines of credit. These types of loans only require that you make minimum payments, but you can pay off any amount, up to the full balance, at any time.

You should always pay down credit card debt as fast as you can. You want to get to a stage where you can afford to pay your balances in full every month and avoid interest altogether. Not only do you save interest, but keeping your balances below 30% of your limit is better for your credit score.

Benefits of paying off a loan early

So we’ve run through the math, but what about other reasons to pay off debt early?

• You save money you can use towards other purchases, such as a house or car.
• You’ll be in a stronger financial position with reduced financial risk to an unexpected life event like a lost job, illness or divorce.
• Less interest means more cash flow in your pocket every month, reducing the risk of missed payments or juggling one debt to pay another.
• You’ll have more control over your finances and more flexibility to make better financial decisions in the future.
• If you have a lot of debt, reducing balances lowers your debt-to-income ratio and your utilization rate, which can improve your credit score.

If nothing else, wouldn’t you just like to pay off your debt as quickly as you can? Paying off your debt gives you peace of mind. You won’t be worried about making your next payment and won’t be worried about a financial emergency. Having less debt reduces your stress significantly.

How to make extra payments fit your budget

The disadvantage or obstacle to paying off debt earlier is you have to come up with the funds to make larger payments every month. Doing that can seem daunting.

However, you can pay down debt faster if you have a plan. Here are some tips to help you create a debt reduction strategy that works.

1. Round up your payment amount. Let’s say your monthly payments are $130. Round them up to $150 or even $200. This way, you’re putting extra money toward the loan while working within an affordable range.
2. Make micro-payments. As I said earlier, every dollar you put against your debt reduces the principal balance and therefore reduces future interest. Consider making small weekly payments rather than waiting until your bill arrives if you carry a balance on your credit cards.
3. Ramp your payments up slowly. Increase a dollar with every payment. If you paid $100 this month, pay $101 the next month. You are much less likely to notice this incremental hit to your budget.
4. Pay weekly or biweekly instead of monthly. The earlier you make a payment, the less interest you pay.
5. Make one larger extra payment a year. There is a balance to be made between having an emergency fund or paying off credit. If you are worried about unexpected expenses, save up money in a cushion account. Once a year, take some of that money and apply it towards debt repayment.

As I said, a lot of people deferred loan payments in recent months to avoid late or missed payments. Deferring loan repayment means you still have to pay both the principal and interest later. Deferrals helped you avoid late and missed payments. But now it’s time to catch up. And if you don’t think you can, it may be time to consider debt relief services.

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So how do you know if you have too much debt to handle? What is a recommended or acceptable debt-to-income ratio for an individual?

What is a debt-to-income ratio?

Your debt-to-income ratio (DTI) tells you how affordable your debt repayment is. It can help you decide if you have too much debt or if you can manage your debt payments comfortably.

To calculate your debt-to-income ratio, add up all your monthly debt payments, and divide this by your monthly gross income. To express your ratio in percentage form, multiply it by 100.

As a formula: DTI = monthly debt payments ÷ monthly gross income x 100

Let’s use the 2018 average Canadian total income of $4,000 a month ($48,000 a year) as an example. Let’s also say that your overall total monthly debt commitment is $1,800.

Doing the math, that would be $1,800 divided by $4,000, with the result being 0.45. Now, multiply that 0.45 by 100 (to have your DTI come out as a percentage). The final answer, which is 45%, is your debt-to-income ratio.

To calculate the share of your income consumed by debt repayment, try our easy-to-use debt-to-income ratio calculator.

What is included in your DTI?

The debt-to-income ratio compares how much you owe versus how much you make. If you want a good representation of your financial situation, you want to include everything meaningful to the outcome.

Debt payments to include

You need to sum up your monthly debt payments first, including all types of loans you carry. These should include items like your mortgage payment or rent, car loan, credit card payments, personal loans, student loans, and payday loans. Some people include child support and alimony payments as well, while others consider this to be a monthly expense. If you are struggling with support payments, we recommend adding them as you want a full picture of your risk of default on recurring financial obligations.

What income to include?

Once you’ve added up all your debt payments, you need to divide them by your monthly gross income (MGI). This is the total amount of money you make every month before taxes.

Your gross income is different from your take-home pay or net income, which have taxes deducted. Gross income also still includes the amount that you’d pay towards any employment insurance, Canada Pension Plan (or Quebec Pension Plan), and any benefit deductions by your employer.

Include all income sources, including employment income, pension income, government benefits, student grants, support payments received, etc.

Self-employed contractors should include gross income less business operating costs but before any personal taxes.

If your income is variable, take your annual income and divide by twelve. Estimate on the low side, excluding any bonuses or commissions you may not earn.

What is an acceptable level of debt at your income level?

Most people we meet carry a lot of debt like credit card debt or lines of credit that only require a minimum payment each month. Minimum payments are never enough to get you out of debt. In fact, they are designed by the banks to keep you in debt. Our recommended ratio limits reflect this type of bad debt. If you are paying more than the minimum on your credit cards, good job. You can adjust the sensitivity of our recommendations a little to your benefit.

Based on our experience, here is what your debt repayment ratio can mean:

30% or less: You are probably OK. Debt repayment is not consuming a significant amount of your monthly pay, leaving you room to increase your payments enough to pay off your debts on your own. Using the tools in my last email, build your budget, create a repayment plan, stick with that plan and you will likely find yourself in much better shape within a year. 

31% to 42%: While you may be able to manage with a debt repayment ratio this high, you are at the maximum range of acceptable. If a significant number of your debts have variable rate interest (like lines of credit) start working to reduce your debt now as rising interest rates will mean more of your paycheque will be going towards debt repayment in the future. If you are only making minimum payments, next month keep your payments the same. Having a higher, fixed, monthly payment, will help you get out of debt sooner. 

43% to 49%: This is cause for concern. Any variation in income or interest can put you in the danger zone. If you only included minimum payments, you may not have enough room in your income to increase your payments enough to pay off your non-mortgage debts. We help many people with debts in this range make a successful proposal for partial repayment to their creditors. 

50% or higher: Dangerous. If debt repayment is taking up more than 50% of your paycheque, you are facing a debt crisis that you probably can’t deal with on your own. It’s time to talk about options for debt forgiveness, so you can lower your monthly payment to a much more affordable level. 

Importance of knowing your debt-to-income ratio

Loan approvals

While your debt-to-income ratio does not affect your credit score, it is another measure lenders use when deciding to extend credit.

Credit scores assess payment and credit history and a person’s current borrowing portfolio and credit utilization ratio. A debt-to-income ratio helps lenders gauge if a borrower can afford higher monthly payments when taking on new debt. The reason is that consumers with a higher DTI ratio are more likely to default. 

In other words, credit scores measure creditworthiness, and debt-to-income measures affordability.

Another ratio you should monitor when it comes to credit cards is your debt-to-credit limit. Your debt-to-limit calculation is your credit card outstanding balances divided by your credit card limits. Keeping this ratio below 30% at all times is better for your credit score.

Mortgage affordability

A mortgage lender use two related income ratios to determine if your potential mortgage is affordable: Gross Debt Service (GDS) and Total Debt Service (TDS) ratio.

GDS looks at your total housing costs (including your mortgage payment, insurance, heating costs, property taxes, and condo fees) as a percentage of your gross income. They recommend your GDS not exceed 35%.  TDS adds non-mortgage debt repayments to the calculation and should not exceed 43%.

Including a broader range of housing costs, is the most conservative way to measure your DTI.

Financial or insolvency risk

There is also a strong link between over-indebtedness and elevated risks of financial shocks.

From an individual’s perspective, such shocks come from unexpected life events. It’s common for people to be able to handle their debt payments until they lose a job or have their finances stretched thin through a divorce or a severe health condition. Unexpected events, when combined with high debt levels, are the most common causes of bankruptcy.

Help you prioritize debt repayment and savings

Too high a debt load isn’t just about keeping up with your monthly payments. The more debt you have, the less you can save.

A lower debt ratio would mean having more disposable income. This, in turn, gives you more chances of saving up and building an emergency fund.

How to bring your debt-to-income ratio down to an acceptable range

The first step is to build a debt repayment plan. Make a list of your debts and rank them from highest rate to lowest rate.

Next, check which lenders allow early repayments without penalties. Contact your loan provider to find out if they have a cap for prepayments. Then, every time there’s room in your budget, make the maximum (if there’s any) prepayment on those loans.

I recommend paying down high-interest debt first. The bigger your repayments towards these debts, the less interest you pay. Just make sure that you also keep making at least the minimum payments towards your other loans.

If you don’t have loans with sky-high rates, you can also prioritize paying off the smallest one first. Once you get rid of that debt, move on to the next one with the lowest total debt amount. Keep working your way up until you erase all of your debts.

Aside from paying off your existing debts, here are other ways that can help reduce your DTI.

• Avoid taking on more debt
• Transfer some of your debts to a low-rate loan or credit card, so your payments go further towards principal reduction
• Use any extra income or budget savings to make more significant payments towards your debt
• Make small micropayments throughout the month to help avoid late fees and lower interest costs

What to do if your debt ratio is too high

I meet with people every day who have built themselves a plan to pay off their debt, then failed because of one common thing they didn’t know ahead of time – their monthly debt obligations were too massive to repay on their own, even with their best efforts.

If your existing debt is too high, you may need to consider these debt relief options:

Consider getting into a debt management plan (DMP)

A debt management plan is a repayment program managed by a credit counselling agency. It involves the consolidation of unsecured debts into a single, easier-to-manage monthly payment. A DMP is different from a debt consolidation loan, however, in that it’s not a new loan.

While enrolled in a DMP, you’ll still owe each original lender. However, you’ll enjoy much lower or no interest rates on debts included in the program.

A DMP will have an extra fee amounting to about 10% of your total debts. A potential drawback to a DMP is that it may not be able to consolidate all the loans you carry.

Explore your debt consolidation options

Unlike debt management plans, debt consolidation involves taking on an entirely new loan. You’ll work with a new lender who’ll issue funds that you’ll then use to pay off multiple debts.

Debt consolidation loans should provide a lower interest rate and monthly payment amounts.

Speak to a Licensed Insolvency Trustee

Licensed Insolvency Trustees (LITs) are professionals regulated by the federal government to help people manage overwhelming debt.

If you’re concerned about your debt, we’d be happy to talk with you about your situation and how a consumer proposal or bankruptcy can help you eliminate overwhelming debt.

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That doesn’t mean, however, that whenever and wherever you apply for a loan, you are going to get the best rate you should based on your credit score.

Certain lending institutions, particularly a lot of predatory loan companies, specialize in loaning money to certain types of credit profiles. Understanding your credit risk classification can help you understand your borrowing risk when applying for a loan and help you avoid taking on a predatory loan when you don’t have to.

What’s your borrower risk profile?

While a credit score ranges from 300 to 900, credit bureaus help lenders make decisions on how to price credit by fitting people into different credit risk categories.  

Different credit bureaus have different credit scoring systems, ranges, and names, but according to TransUnion’s CreditVision risk score, your profile can fall into one of the following categories:

Subprime: Credit score between 300 and 639 (bad or very poor).

Near Prime: Credit score between 640 and 719 (poor or fair)

Prime: Credit score between 720 and 759 (good or average)

Prime Plus: Credit score between 760-799 (very good)

Super Prime: Credit score of 800 or higher (excellent)

Factors that go into determining your borrower profile are those common to any credit rating: your payment history, credit utilization, type and age of credit, and negative marks such as collections, hard inquiries, or legal items on the public record section of your report like a judgement, bankruptcy or consumer proposal.

More creditworthy borrowers (super prime and prime plus) get a lower interest rate and have no problem borrowing from a traditional financial institution.

Prime and near-prime borrowers may have to offer collateral to avoid paying higher rates.

Near-prime and subprime borrowers have fewer borrowing options. You may need to apply for a secured credit card and may only qualify for a personal loan through a secondary lender. But that doesn’t mean you should not be aware of what a bad credit loan means.

Understanding subprime lending options

Borrowers who are in the near-prime and subprime risk category are often the most desperate. They are most susceptible to predatory lending options like a high-interest installment loan, payday loan, or high-ratio private mortgage.

These are the types of loans that often trigger insolvency. Already living on credit with maxed-out credit card debt, many of our clients seek loans from lenders of last resort like Easy Financial, Fairstone, Borrowell, to name a few.

There is nothing illegal about what these lenders are doing. But if you consider applying for one of these loans, it’s crucial to understand the full terms you agree to upfront.

Amount borrowed: $5,500
Interest rate: 46.9%
Cost of borrowing: $6,575.15
Total owing: $12,075.15
Guess how much he thought he owed?

— Scott Terrio (@ScottTerrioHMA) March 16, 2020

Many loan providers specialize in more risky subprime loans. Think low or bad credit car loans, fast cash payday, and low-credit installment loans with rates of up to 59.99%.

The problem for consumers is the cost is not always identifiable without reading a lot of fine print, and until after you’ve submitted your application. Some subprime lenders use predatory lending practices like publishing teaser rates (interest rates starting at 8.99%) to get your loan application in the door.

I get that these loans can help someone who is already a deep-prime or subprime borrower establish better credit, but in most cases, that’s not why they are applying. Most consumers are taking on these loans because they:

• Are easy to find on the internet
• Have a ridiculously easy application process
• Put money in your account faster than a traditional lender often will

Understanding the risks of borrowing money

Borrowing is the act of using someone else’s money to pay for something you need or want today. In return, you agree to pay interest until you can pay the loan back. Approaching a subprime lender means you will pay more in interest and have to work much harder to get out of debt. You owe it to yourself to know who these lenders are. If you don’t need to use them, don’t. Work to improve your credit if they are your only option before taking on a loan if you can.

Not only does a lender take on risk, so do you as the borrower depending on what type of borrower you are. If you keep your balances low and pay your bills in full every month, that’s great.

However, there are risks to you, as well as your lender, when you take on a loan:

• You lose future spending power as debt payments consume a higher percentage of your take-home pay.
• You may not be able to afford your payments. Defaulting on loans will lower your credit score further and can lead to collection calls or wage garnishment.
• You could end up so deep in debt that a bankruptcy or consumer proposal is in your future.

While filing a bankruptcy or proposal is not the horror most people make it out to be, it’s still something we know you want to avoid if you can. Making good borrowing decisions about the type of loan or credit line you take on goes a long way to helping with that.

Before you take on any loan, subprime or superprime, know the risks and total costs going in. Make sure the payment fits within your existing budget. Don’t use credit as a way to balance your budget. And if you are already in too deep, reach out, we’re here to help.

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Predatory lending involves loans that are expensive and almost impossible to repay because they come with high-interest rates and fees. Predatory lenders prey on vulnerable borrowers desperate to solve an immediate cash crisis or offer credit where no-one else will. Subprime loans specifically target consumers with low or no-credit. These types of lenders often use unfair and deceptive sales practices that disguise the true cost of borrowing.

Most Canadians know that payday loans are costly and a bad idea. But there are other types of predatory loans you should avoid. Predatory lending practices can be found among low- or bad-credit car loans, fast-cash installment loans, and even private subprime mortgage lending.

What are the warning signs of predatory lending?

Innovations in lending through new FinTech companies has increased the popularity of easy access and subprime loans. Online lending has expanded the reach of predatory lenders quite significantly. New products are coming out all the time. Not just a payday loan, these companies are offering lines of credit, term loans, business loans, and fast instant loans of up to $45,000, or more.

It’s important to spot which of these loans will likely cause you more financial trouble. Here are 7 common signs of predatory lending:

Excessively high interest rates and hidden fees

Payday loans are the costliest type of loan you can get, charging fees equivalent to triple-digit interest rates. In Ontario, if you get a payday loan and pay it off in two weeks, you are paying an annualized interest rate of 390%.

Canadian usury laws limit the rate lenders can charge on a loan to 60%.  Payday lenders get around this because they are regulated provincially, and so are exempt from this federal law, and because they set their charges in the form of fees, rather than interest rates.

However, some other lenders provide credit to consumers with limited or poor credit histories at close to usury rates. It is not uncommon for us to see clients with installment loans bearing rates of 39.99%, 49.99% and even 59.99%. While ‘better’ than payday loan rates, these loans still trap many consumers into a debt cycle that is hard to break.

Loan terms can also come with extra fees, including late payment penalties and loan insurance premiums.  These premiums, sometimes not optional, can more than double your borrowing costs.

With costs this high, you can see why our clients struggle to get out of the loan spiral once they borrow.

Easy, fast application process

Predatory lenders tempt you with good customer service. Their service and staff make you feel welcomed, and the borrowing experience is generally hassle-free. At most, you may spend 30 minutes on your entire application before receiving your funds. Online lenders provide an even easier borrowing experience with a short application and cash in your chequing account within minutes.

Do not, however, be fooled by the speed and convenience of the service. Predatory lenders seek to minimize the number of questions you ask before encouraging you to sign their terms of agreement. Predatory lenders count on customers not understanding their borrowing terms or seeking other options.

No credit check required

A good indicator of predatory lending is when you see a company advertise “no credit check required or necessary.”

A lender generally asks to see your credit report because they want to answer some common questions about your creditworthiness, like how much debt you already have and what your payment history looks like. A credit check is how a lender assesses just how risky it is to loan you money. 

Predatory lenders already know you are high risk, and they offset the risk of lending without credit checks by charging high interest rates and fees on their loans. You should always be wary when a company is willing to lend money without asking any questions about your finances and ensuring you have the ability to repay the loan in full.

Repeated refinancing and rollovers

Predatory lenders know many of their clients will never repay their loans in full. In fact, they make more money when you remain indebted to them for longer. Car-loan rollovers are a predatory loan practice among vehicle lenders. Even though you were unable to pay the full principal owing on your original car loan, you can refinance your new vehicle by rolling your old, unpaid debt into your new loan. This can worsen your financial situation and result in you owing more than your car is worth.

In Ontario, borrowers can’t get another payday loan from the same lender before paying off their first loan. Unfortunately, many people get around this by visiting another payday loan company, which is why our average client owes money to almost four different fast cash type lenders at the time of filing.

Lenders also offer extended repayment terms but with additional fees and again, very high interest rates. Postponing repayment simply makes it harder to get out of debt in the future.

Loan costs are not obvious

A predatory lender will rarely directly tell you the high cost of borrowing their loans. They are experts at deceiving customers.

Payday lenders advertise their loan costs as $15 for every $100 advanced. While that doesn’t sound expensive on the surface, the actual APR (annual percentage rate) on those borrowed funds is 390% (assuming you have the loan for two weeks).  Would you take an advance on your credit card if your card issuer told you it would cost 390%?  Probably not, so why agree to this cost with a payday loan?

But even if you say payday lenders have a bad reputation and should be avoided, other loan companies also try to make their loan costs less obvious.

Here is a screenshot of an online offer for installment loans as an example:

The focus is placed on the large amount you could borrow and a lower annual interest rate than a payday loan. Notice the use of language: “loans up to $45,000,” and “rates starting from 19.99%” with a bold call to action to get a loan. Sounds attractive, and many borrowers are likely to go ahead and proceed.

But let’s examine the small print below the button:

They state the potential APR is between 19.99% and 46.96% – this is a wide range, and it suggests that you may not qualify for the lowest rate.

Our advice: always read the fine print and even then, ask questions to determine your total loan repayment with interest. If a lender is not willing to give you a clear answer about costs, this is a good sign that they should be avoided.

High-risk secured lending

Another form of predatory lending involves borrowing against assets you own, like your car or home equity. This type of secured loan attracts borrowers who have poor credit and are looking to consolidate multiple debts.

A common example is a car title loan. But should you really borrow against the value of your vehicle or your house?

High-risk secured lending allows the lender to repossess the assets you offered as collateral should you fail to repay your loan. Borrowers can be sued for any shortfall once the asset is sold.

These loans are also not cheap and can come with an interest rate of at least 35%, plus additional fees.

If you are taking on a new installment loan to consolidate debt, you may want to consider healthier debt relief options as an alternative.

Masquerading as savings or credit repair loans

A hidden form of predatory lending is called a savings or credit repair loan, which offers to do just that – “improve your credit score” or “automatically build up your savings.” Unfortunately, these loans achieve neither objective and often create more debt problems.

Under these agreements, you make a monthly payment but receive no money yourself until the end. The ‘lender’ charges a $200 setup fee upfront and interest rates on the ‘loan’ of over 25%. Effectively, these lenders are charging you to put money into a savings account for you. These programs take money from you monthly that could be used to pay off other debt or build an emergency fund (so you won’t need a fast cash loan), and won’t fix your credit any faster than you can on your own.

Who is at risk?

People turn to high-cost loans because they feel they have no alternative. The problem is, since predatory loans are so hard to repay, they increase your financial risk.  Predatory loans are a short-term fix but a long term problem.

Almost anyone can get caught in a predatory loan trap. Lenders target specific consumer profiles, appealing to the financial needs of seniors and placing attractive lifestyle ads to millennials. Our bankruptcy study shows that, in 2019, 24% of insolvent debtors 60 and older and almost half (48%) of those aged 18-29 had at least one payday style loan.

You should avoid predatory loans if you:

• Already have high or rising debt balances
• Are making minimum payments only on other debts
• Are already receiving collection calls
• Have received a wage garnishment or other legal notice from creditors
• Do not understand the full borrowing terms or process
• Cannot balance your budget without resorting to even more credit
• Do not see yourself able to repay the loan, with interest, within the loan term.

Who regulates predatory lenders in Canada?

Under section 347 of the Criminal Code, interest rates in excess of 60% per year are illegal in Canada. Advocacy groups, like ACORN Canada (Association of Community Organizations for Reform Now) would like to see that limit reduced to 30%.

Payday lenders are regulated by the provinces and are exempt from Canada’s usury laws. In Ontario, the Payday Loans Act set the maximum fee for a payday loan at $15 per $100. Most people still think that is too high, and we believe the provincial government didn’t go far enough to regulate payday loans effectively.

Some municipalities are also trying to legislate some predatory loan practices. Hamilton, Kingston, Toronto, and Ottawa, for example, have all introduced legislation to limit the number and location of payday loan stores.

Unfortunately, as I noted, predatory lending involves more than just payday loans. And with many providers moving online, municipal regulations will not completely solve the problem.

Predatory loans are not illegal. While their marketing practices may lure people into a problem loan, these loans are entirely within the laws of Canada. This differs from advance fee loan scams, which are illegal. Canadian lenders are prohibited from charging you an upfront fee to guarantee loan approval or to process your application.

The best form of control is to ensure that lenders clearly advertise their full and true loan costs. At Hoyes Michalos, we also advocate for the end to teaser and introductory rates as these lead consumers into higher-cost loans in the long run.

In truth, it is up to you, as the borrower, to avoid these types of loans.

How to protect yourself from predatory loans

Predatory loans are easy to spot. The terms and conditions overwhelmingly benefit the lender. Loan qualification standards are low or non-existent. There are significant fees on top of an already sky high interest rate.  Loan documents are confusing, or there is too much fine print for you to understand what you are agreeing to clearly.

Financial literacy is the first step in avoiding these types of loans. Here are some steps you can take to protect yourself from predatory lenders:

1. Spot the warning signs like high interest and additional fees
2. Don’t be pressured into a loan
3. Read all terms and conditions before you sign
4. Long term – build a budget, and create an emergency fund so you don’t have to rely on fast cash loans for an unexpected expense.

Consider alternatives to predatory loans

If you are under pressure for immediate cash due to an emergency, there are many cheaper alternatives to predatory and payday loans, including negotiating with your creditors, borrowing from friends and family, or paying with a credit card, for example. Yes, even a cash advance on a credit card at 21% is better than an installment loan at 49%.

However, it’s essential to know that more debt is not always the answer. It may be better to focus on eliminating debt rather than taking on another loan, which will only make your cash flow problem worse.

One option may be to make a realistic and affordable debt repayment plan through a consumer proposal, where you pay no interest, no up-front fees, and can reduce your debts by up to 70%.

If you do find yourself deep in debt with troublesome loans, our government-licensed experts would be happy to review your situation with you and discuss options other than taking on another bad loan.  Contact us today for a free phone or video consultation.

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Advantages and disadvantages of a joint application

When you apply for a joint debt or loan as a couple, you are saying to the lender: we would like to use our combined credit capacity, and our combined income, to support our loan application.

There are advantages to applying together for a debt consolidation loan.

• If one spouse’s debt-to-income ratio is too high, you can use the income of the second spouse to improve this lending factor.
• Similarly, if one partner has a bad credit score, the application may be approved on the merits of the second co-applicant or cosigning spouse.
• By improving the quality of your application and overall creditworthiness, you may qualify for a lower interest rate loan than the high debt spouse can acquire.

While you can borrow more money with a shared application, the downside is that as co-borrowers, you both will be legally obligated to repay the loan.

A joint debt creates what is known as a ‘joint and several’ liability. Both parties are 100% liable to repay all the debt. This can create significant financial risk for the spouse that is now assuming responsibility for debts created by the other spouse.

Credit score issues

Lenders are in the risk management business. To qualify for a low rate consolidation loan, at least one applicant will need a good credit score. You are relying on the positive credit history of one spouse to override the negative history of the other.  However, making a joint application means that the debts that were affecting your spouse’s credit score will now impact yours. 

• Your credit score may fall because you have taken on new credit.
• Multiple applications create hard hits on your credit report that can also hurt your credit score.
• A new loan can also increase your credit utilization ratio until you begin to pay down the consolidation loan.

Marital breakdown

Joint debt means you are responsible and liable under the terms of a signed loan agreement. It doesn’t matter who says they will pay the loan. If you divorce or separate from your spouse, and they stop making payments, the lender will look to you to repay the debt.

Debt cannot be allocated in a divorce or separation agreement. While your separation agreement might call for a 50-50 split of debts, or your spouse might agree he will make the monthly payment because the debt was his originally, the agreement between the two of you has no legal impact on your lender.

Further, it is not possible to have a name taken off a joint loan without the lender’s permission, and because the lender approved the loan based on a joint application, they may not be willing to do so. In the event of a marital breakdown, you could be left with payments you can’t afford.

Marital assets and property

Another factor to consider is whether you want to risk any family assets to consolidate unsecured debt like credit card debt.

Converting unsecured debt into a secured consolidation loan is one of the riskiest consolidation strategies we see.

If you are fortunate enough to own a home, a home equity loan, or home equity line of credit can seem like an attractive loan consolidation approach to deal with one spouse’s problem debt. However, merging family debt into your mortgage creates two financial risks; you are now liable for larger mortgage payments and, if you and your spouse default, you risk losing your home.

Income stability

One of the most common reasons people find themselves unexpectedly filing a bankruptcy or consumer proposal is a job loss or income reduction. Consolidating debts with your spouse means you are both equally responsible. If one spouse loses their job, you may no longer have the income capacity to keep up with your consolidation loan payments. The option for one spouse to file bankruptcy to deal with their separate debt, leaving the other financially stable, is off the table once you agree to consolidate your debt legally.

Student debt

With student loan debt is a growing issue among millennials, many are entering their marriage years already in debt. Today 1 in 5 of our clients carry student loan debt, and this rate is growing rapidly. If one spouse has been unable to earn enough to repay their student loans, it may make more sense for them to consider student loan relief options rather than burdening the two of you with ongoing loan repayment.

Student loan consolidation is also not always a good idea as you can lose the tax benefits of the deductibility of interest on Canada student loans.

Is a joint loan the best option?

Problem debt is problem debt. It may not make sense to shift bad debt to your partner. This may not help either of you get out of debt.

The reason most couples consider a joint consolidation loan is to use the good credit history of one spouse to help the other deal with overwhelming debt. However, if one spouse is experiencing financial hardship because of their loan payments, burdening the second spouse with the same joint legal obligation may not be the best course of action.

Before consolidating one spouse’s bad debts into a family debt, it may make more sense for the spouse with debt issues to talk with a Licensed Insolvency Trustee about loan forgiveness. The spouse with high consumer debt may want to consider filing a bankruptcy or consumer proposal as a form of debt relief rather than transfer the debt obligation to the other.

There is a secondary benefit in keeping personal responsibility for personal debts. This can preserve the credit rating and credit capacity of the spouse with good credit for future needs. That spouse can still qualify for a mortgage while both spouses save money for a down-payment after completing a consumer proposal, for example.

Filing insolvency does not affect your spouse’s credit. This is one of the common misconceptions of how a bankruptcy filing impacts a spouse. The spouse filing insolvency can work to improve their credit without harming the credit of their partner.

In the end, you must decide as a couple about consolidating your debt through a joint loan. Talk together about how and who will make the monthly payments, what happens if your finances or relationship changes, and how refinancing with a joint consolidation loan will affect your future financial goals.

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