The APR Red Herring
The Annual Percentage Rate is a way of standardizing the cost of credit. It is simply the interest rate plus any additional cost associated with borrowing money and it serves as an important metric to compare different credit options. However, the media, regulators and government often fixate on this number and miss the underlying borrower narrative.
Let’s take the credit journey of an average Sue Canadian. Sue has a financial emergency. She walks into her bank and asks for a loan. The bank pulls her credit profile and will provide an APR which matches her risk score. If she is outside the bank’s risk appetite, she may have to use her credit card at a 24% APR. However, if Sue, like 7 million Canadians, doesn’t qualify for any form of credit at her corner bank, she needs to look elsewhere for a loan.
Sue could be new to Canada without an adequate credit history, her credit could have been negatively impacted by a divorce or a layoff. Regardless, Sue requires credit. There are a wide range of installment loan options that service high-risk profiles but if Sue falls into a high-risk credit bracket, the cost of providing the capital that she requires for an emergency health issue or car repair could be sufficiently higher than the bank’s rate.
Now if a lawmaker tries to protect Sue from high APRs by pulling down the legal rate, Sue could find herself on the wrong side of the business case based on her credit rating. She would likely find that she is no longer served by mainstream leaders. What are the alternatives at this point? Are we driving Sue into an unregulated marketplace? Are we pushing Sue towards high-cost payday loans which do nothing to nurture Sue towards a prime rate.
Presently the criminal interest rate under the Criminal Code of Canada (Section 347) has a ceiling of 60%. On a province-by-province basis, Sue is protected by customer protection laws. If we mistakenly try to help Sue by focusing on forcibly lowering APRs, we eliminate much of Sue’s and other Canadian’s safety net.
Ultimately, we need to think of lending as a continuum. There is no line that delineates one loan from another. What we, as a community, need to do is help to move higher-risk borrowers that are charged a higher cost for lending towards prime lending opportunities. As a community this is our goal. Every lender makes sure that all loan decisioning takes into account Sue’s ability to repay and importantly, nurtures her towards prime by reporting her repayment history to the credit bureau.
If you do not consider APRs as a continuum, you create artificial lines in the sand that limit or in many cases eliminate access to credit.