Beware high-interest instalment loans

When your back is against the wall and you're looking for a debt repayment solution, many seemingly great solutions will arise. Instalment loans are one way to get money fast, but some lenders' high interest could put people already in debt at even greater risk.

An instalment loan is any loan that's repaid over time with a set number of scheduled payments. When you finance an appliance, for example, you may be taking out an instalment loan. However, many independent lenders that exist outside the traditional banking system are now offering high-interest instalment loans.

Instalment loans have their place. They can be the first step in helping a cyclical payday loan borrower. A payday loan is a cash advance borrowed at a very high interest rate. The borrower usually writes a post-dated cheque for the amount and it's typically cashed on the borrower's next payday. While the interest on an instalment loan from an independent lender is still high, paying monthly means the interest is lower than a payday loan where it can be as much as 20,000 per cent.high-interest

But high-interest instalment loans still garner a lot of criticism. "I classify lenders into three groups," says Peter Gorham, president and actuary at JDM Actuarial Expert Services Inc. in Ontario. "There are the banks and the other companies that are looking for very high quality [loan candidates]; the second tier that will lend to people who don't qualify for a bank loan; and then there's this group of firms that are lending to the people with the worst credit records."

Companies such as Easy Financial offer loans at an annual
percentage rate (APR) of 46.96 <per cent> or higher. Equifax attributes at least part of Canada's total $1.88 trillion in debt in 2015 to high-interest instalment loans.

"The problem with these types of loans is high interest rates usually mixed with an already marginalized ability to stay afloat financially," says Keith Emery, operations director of Credit Canada Debt Solutions, a credit <counselling> service with offices in several provinces across Canada. In other words, it may feel like your last and only option as you desperately try to regain control of your situation. And at first glance, it may not seem like a bad offer.

It's not entirely your fault
While annual interest rates for high-interest instalment loans are often lower than a payday loan, the effective APR on a high-interest instalment loan is often only a few percentage points from the legal limit of 60 <per cent>.

The APR is the daily periodic rate of interest multiplied by the 365 days in a year, while the effective annual interest rate is the daily periodic rate of interest compounded to the 365th power, so the effective annual interest rate is what you're actually paying for every day you carry a balance.

"Loan companies are legally required to disclose the APR on a loan, but they do not have to disclose the effective rate," says Gorham. "Generally, but not always, an APR of around 47 <per cent> will give you a 60 <per cent> effective rate."

Additionally, payday loans are highly regulated in almost all provinces, with lenders legally having to disclose the amount you're borrowing, the amount of days the loan is for and what you will pay to borrow the money all on the first page of the contract. Instalment loans are not regulated to the same degree. However, with proposed legislation in Ontario and new legislation enacted in Manitoba in January 2016, this may change, especially as these high-interest loan institutions continue to proliferate across the country.

"The question is, what is the legal obligation of these lenders to refer their customers to credit <counselling> if they need it?" says Gorham. "The system needs balance and needs a way to protect people from being their own worst enemies, but I'm not sure how you do that. I'm all for financial education, but I'm not sure how you impose on private businesses to put that balance in place."

How to dig your way out
If you've already taken out one of these loans and are struggling with it, what should you do? Your first, and likely best, option is to try to find the money in your budget.

"Review your full budget to see if there are ways of cutting back so that there are available funds to repay the loan," says Emery. It might be worth scouring for more money in your budget even if you're already making minimum payments -- you can ask the lender if there are ways to make larger payments to reduce the overall interest costs, he says.

Under no circumstances should you take on more loans, even though it is common for these companies to offer you more money. This is especially important if you're at least paying some money back on a regular basis.

"They'll say, 'You're doing a really good job. We're willing to loan you more money. If you need some more cash, we'll up your loan and you can keep the same payments,'" Gorham says. "What they don't tell you is that instead of paying them for the next two years, you'll be paying them for the next four years."

If there's no extra money in your budget or you just can't see a way to get out of your high interest loan, Emery recommends sitting down with a credit counsellor to review your income, assets and debts to determine your best course of action and how to avoid these high-interest loans for good.

"Talk to a not-for-profit credit counselling service to look at how to manage this and other debts you may have," says Emery. "Look at long-term solutions for your financial situation."

See related: 5 factors in choosing a debt consolidation plan, Marketplace lending: The popular peer-to-peer system hits Canada
Published January 29, 2016

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