Predatory lending and payday loans: What it is and how to avoid it
Brooke Thio, Content Specialist
As the rising cost of living hits low- and moderate-income Canadians who can’t access fair credit, the allure of an easy-approval loan grows greater than ever — even if the interest rate threatens financial ruin. When you’re in a pinch and need funds quickly, it’s easy to fall prey to predatory lending, but there are better alternatives to help your financial standing.
What is predatory lending?
Predatory lending happens when lenders use unfair or deceptive tactics to get borrowers into a loan. Often, predatory loans have excessively high fees, interest rates, and abusive terms that a borrower cannot reasonably pay back, trapping them in debt.
Predatory lenders often target vulnerable borrowers, such as those who have low credit scores, limited financial knowledge, or a lack of credit options. They may also use pressure tactics to take advantage of borrowers’ circumstances.
Examples of predatory lending
Some forms of predatory lending are obvious, while others are less so. Here are some of the most common types of predatory lending:
- Payday loans. As the name suggests, payday loans are often short-term loans of small sums of money, “just to tide you over until payday”. However, such loans often come with sky-high interest rates.
- Car title loans. These single-payment loans let you borrow a sum of money in exchange for putting up your car (or other vehicle) as collateral. If you’re unable to repay the loan, your car is seized and you may lose your ability to complete activities like commuting to work, purchasing essentials, or caring for your family.
Signs of predatory lending
When looking for a loan, make sure to assess it carefully. While there’s no clear definition of what makes a loan predatory, here’s what to look out for:
The loan seems to good to be true
Federally regulated financial institutions must disclose information about your loan in a specific manner. On the other hand, predatory lenders may promise more generous loans than you need while also hiding the (often abusive) fees and terms. These include:
- Prepayment penalties. When you’re able to pay off a loan early, lenders miss out on the interest that would have been charged throughout your loan term. Hence, they will usually charge a prepayment penalty (or an “early repayment fee”) that consists of a percentage of your balance or a fixed fee. However, predatory lenders may charge an astronomical penalty in order to keep you from paying off your loan.
- Junk fees. Many payment agreements — not just loans — use compulsory add-ons to extract more money from consumers. For instance, an Internet or mobile service provider might charge activation or termination fees. Beyond the origination fee (which is legitimate), look out for “document preparation fees”, “statement fees”, or “underwriting fees”.
- Balloon payments. Some loans are structured such that you pay small monthly amounts but will owe a large final payment, or “balloon payment”, at the end of the loan. This is more common in business loans, but predatory lenders may use balloon payments to force you into refinancing or extending your loan.
The loan is only asset-based
Most licensed lenders will assess your creditworthiness and ability to repay a loan using your income, credit history, and other factors — even if it’s for a secured loan. However, a predatory lender may simply ask you to put up your house or car as collateral in an attempt to strip you of your equity.
You can’t build credit with the loan
When borrowing from a reputable lender, your loan and repayments are reported to Canada’s credit bureaus (Equifax and TransUnion). This helps to improve your credit score over time so that you can qualify for better credit in the future. Predatory lenders won’t do this.
The lender has a history of complaints and bad reviews
One of the best things to come out of the Internet is the sharing of reviews and experiences. With a little online research, you can find out if a lender has received bad reviews or complaints.
Canadian laws on predatory lending
In May 2024, the Canadian government announced amendments to section 347 of the Criminal Code, reducing the criminal interest rate in Canada. Starting from January 1, 2025, the criminal rate of interest will be lowered from the current 60 per cent effective annual rate (EAR) — approximately a 48 per cent annual percentage rate (APR) — to 35 per cent (APR).
This means it will be an offence for lenders to receive or collect interest at a rate higher than 35% APR. In addition, the cost of borrowing for payday loans will be limited to $14 per $100 (14% APR) in provinces with an approved payday loan regime.
How to avoid predatory lending
If you’re struggling to access fair credit, here are some other options to get money.
1. Choose a trustworthy, authorized lender
Whether it’s for a personal loan, auto loan, or even a mortgage, make sure you choose a reputable lender offering reasonable interest rates and clear terms. Shop around and read reviews, and make sure to read the fine print before you apply.
2. Don’t borrow more than you need
Predatory lenders may persuade you to borrow more, but this can lead to a false sense of security and greater debt. Borrow only what you need, and make sure you have a clear repayment plan in place.
3. Seek alternatives
Before seeking out a loan, consider turning to your community: your family and friends, your religious congregation, co-ops, or income assistance programs offered by your local government.
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How to get out of a predatory loan
The first step to dealing with debt from a predatory loan is to consolidate your debt so you can pay it off as quickly as possible. The key to this is finding a new loan with a lower interest rate and reasonable payment terms. Major financial institutions, such as banks, offer debt consolidation loans.
If needed, seek out a licensed credit counsellor who can help you create a debt management plan. While the plan will impact credit score and prevent you from acquiring new loans or credit facilities, it can help you pay off your debt at a reasonable pace. If possible, try to also increase your income and reduce your expenses as much as possible in order to clear your debt.
Another option is to engage a licensed insolvency trustee — a debt management professional who works for the government — for a consumer proposal. A licensed insolvency trustee can negotiate your debts on your behalf to decrease your interest rates, extend repayment deadlines, or both. A consumer proposal will also affect your credit score, but it is a binding arrangement with creditors, so the negotiated terms of your debts will not change.
Frequently asked questions
Is predatory lending illegal in Canada?
What happens if I can't pay back a payday loan?
The bottom line
Taking a loan can be incredibly helpful when you need one, but make sure you do your research and read loan documents carefully before signing on the dotted line. Beware of aggressive sales tactics like limited-time offers and easy renewals. Above all, seek assistance from a financial advisor if you need help dealing with debt.