Third Interim Report on Cost of Credit Disclosure Act 1994

Part 3 -- Fixed Credit

General Issues Regarding Part 3

Notice of negative amortization: Discussion Notes, A.4.c (pp 12-13)

The issue here is how to address situations where a rise in interest rates creates a situation where scheduled payments do not cover the interest that accrues between payments. Such a situation could arise quite easily where variable rate loan has a long amortization period. The proposed provision set out at page 13 of the Discussion Notes would require the lender to notify a borrower of a negative amortization situation that persists for two consecutive payment periods, and to "invite" the borrower to increase the payments to cover the interest that is generated in each payment period.

The response of commentators to the suggested provision was generally favourable, but there were some concerns and suggestions. One concern was that the proposed requirement might be expensive for some lenders to implement. My impression was that this concern related mainly to the initial costs of implementing such a requirement rather than to its ongoing costs. One commentator thought that requiring the lender to "invite" the borrower to increase the payments to cover the interest did not go far enough; there should be a requirement to increase the payments so as to cover the interest. However, another commentator noted that it will generally be in a lender's own best interest to ensure that the periodic payments are at least sufficient to cover the interest. Another commentator suggested that if the payments are increased and the rates later decline, the borrower should have the option of leaving the payments at the higher level or going back to the original payments. Finally, one commentator enquired

whether the potential for a future negative amortization situation during the term of the loan with full up front client disclosure of the potential and subsequent ramifications, could be considered deliberate and therefore not subject to the provisions as set out in the Discussion Draft.

This question undoubtedly related to the comment on page 13 of the Discussion Notes that "of course, [the proposed provision] would not apply where the negative amortization situation is deliberate and has been disclosed in advance." The comment to which the commentator referred was actually a reference -- albeit a rather vague reference -- to "reverse mortgage", which are discussed earlier in this document.

The comment in the Discussion Notes about deliberate negative amortization situations was not meant to suggest that the special disclosure provision would not apply if the borrower had been informed at the outset of the loan that future increases in the interest rate could create a situation where the scheduled payments would not cover the interest. Such advance disclosure of the potential for negative amortization is desirable, but would not ensure that borrowers are informed when their scheduled payments in fact do not cover the interest generated in each payment period. It is one thing to know that a negative amortization situation might arise because of future interest rate increases; it is quite another to know that such a situation has actually arisen. Therefore, the special disclosure requirement set out in the Discussion Notes would be triggered even if the borrower had been advised that future increases in interest rates might lead to the interest generated in each payment period exceeding the payment due at the end of the period.

Recommendation 15:

The special disclosure provision set out on page 13 of the Discussion Notes should be adopted.

Balloon payments: Discussion Notes Part A.4.d (p. 14)

The Discussion Notes point out that CCDA does not restrict "balloon payment" arrangements, while noting that one province (Quebec) currently does not allow balloon payment arrangement for non-mortgage loans and that several other provinces have expressed sympathy for taking the same approach. The Discussion Notes state that individual jurisdictions could decide whether or not to prohibit balloon payment arrangements. Only two commentators commented on this aspect of the Discussion Notes. One commentator argued that balloon payment loans benefit consumers by allowing for smaller monthly payments. The second commentator expressed grave misgivings about the decision not to include a provision in CCDA that prohibits balloon payment loans, because balloon payment provisions reduce the transparency of the actual cost of credit.

Recommendation 16:

No change. CCDA should not prohibit or restrict balloon payment arrangements, leaving individual jurisdictions free to do so if they choose.

Annual notice: Discussion Notes, Part A.4.e (pp 14-15)

The Discussion Notes sets out a possible provision (on p. 14) that would require lenders to provide borrowers with an annual statement for all fixed loans with terms in excess of two years.[24] The basic purpose of the notice would be to let borrowers know what progress they have made in paying off the loan and how the payments have been applied. Commentators were asked to address the issues of whether this provision would create practical problems for lenders and whether it would be more appropriate to provide such statements "on request" than on an annual basis.

Several commentators commented on this provision. The range of views is indicated by the response of one credit grantors' organization:

The suggested provision for the annual statement creates problems for some of our member companies as they do not have the necessary systems to comply with the requirement to provide an annual statement. However, other members would prefer distributing these statements to our customers on a one time basis rather than when it is requested.

Another commentator pointed out that few borrowers ask for such statements, but that when they do the statements are provided as a matter of "customer relations and law". This commentator thought that a requirement for an annual statement would be costly and would be useful to very few borrowers. Most commentators, however, supported the idea of annual statements for loans with a term in excess of two years.

Recommendation 17:

Either

(1) Adopt a provision based on the provision set out on page 14 of the Discussion Notes; or

(2) Lenders should be required to provide borrowers with information regarding the application of payments upon request without charge, subject to reasonable restrictions on the frequency of such requests.

Section 16 Requirements for variable rate agreements

Additional Reference: Discussion Notes, Part A.4.a (pp 10-11)

Note

The Discussion Notes asked whether requiring that variable rate fixed loans be indexed would create significant difficulties for consumers or lenders. Several commentators responded to this question. None thought that it would create significant difficulties. One commentator pointed out that it is important to ensure that the differential between the rate and the index is fixed for the length of the contract and does not change on default. This point is dealt with in section 6 of PIA 2, and is one of the four principles that I suggested earlier should be implemented by any replacement for the Interest Act.

Section 18 Disclosure triggered by mention of interest rate for constant-rate loan

Clarification

One commentator wondered what was meant by the "nature" of disbursement charges in clause (c). What is meant, and hopefully this is clear from the context, is that the advertisement must disclose what sort of disbursement charges (e.g. legal fees) may be imposed on the borrower, but is not required to disclose their amount.

Sections 24 Timing of initial disclosure[25]

Additional Reference: Discussion Notes, Part A.4.b (pp 11-12)

Two commentators objected to allowing borrowers who exercise their special two-day cancellation right to escape liability for flat charges (ss 24(2), 27(3)). They argued that it is wrong in principle to allow borrowers to avoid charges for expenses, even internal expenses, that have been incurred by the lender to set up the loan in question. This will shift the cost from prospective borrowers who back out of the loan to actual borrowers.

These points are well taken. However, for the reasons set out in the Discussion Notes, I believe that borrowers who decide not to proceed with the loan (or who repay it) within two days of receiving the disclosure statement should not be responsible for any flat charges. As already discussed, several provinces and commentators have strong reservations about allowing flat charges at all for fixed loans. The proposed "two days to think about it" rule is intended to be one mechanism for keeping the amount of flat charges at competitive levels. Of course, if flat charges were not permitted at all, this would be a moot point.

Recommendation 18:

Confirm the "two days to think about it rule" in sections 24(2) and 27(3) and 28(3).

Section 30 Contents of initial disclosure statement

Issue

Subsection (3) relieves the lender of the requirement to disclose the total amount of the payments and the dollar cost of credit for loans with a term exceeding five years. The corresponding provision in CCDA 2 referred to loans with an amortization period exceeding five years. The rationale for this exclusion was discussed in the Commentary to CCDA 2 (Commentary: Part II.F.3.b.(2)). The Commentary noted that existing disclosure legislation does not require disclosure of the total payments or dollar cost of credit for mortgage loans. The Commentary provided a rationale for this exclusion that focused on the long amortization period for most mortgage loans and the fact that the amortization period for mortgage loans generally exceeds their term. The Commentary argued that the rationale for the exclusion applied to any loan with a relatively long amortization period, not just to mortgage loans: hence, CCDA 2's reference to loans with an amortization period of more than five years. However, the working group thought that the exclusion should be limited to loans whose term exceeds 5 years, and CCDA 3.2 has been modified accordingly.

One commentator on CCDA 3.2 argued that the change from "amortization period" to "term" was inappropriate. The commentator referred to the rationale for the exclusion set out in the Commentary, which focuses on the length of the amortization period rather than the length of the term. This is correct; the Commentary's rationale for not requiring disclosure of the total payments and dollar cost of credit in certain circumstances focuses on the length of the amortization period. Indeed, the strongest argument for not disclosing the total payments and dollar cost of credit can be made where the term is short but the amortization period is long. In retrospect, the safest and simplest solution is to maintain the existing distinction between mortgage and non-mortgage loans. That is, disclosure of the total amount of payments and dollar cost of credit would be required for loans other than mortgage loans.

Recommendation 19:

Modify subsection 30(3) so the exclusion applies to mortgage loans, rather than loans with a term [or amortization period] exceeding 5 years.

Section 31 Variable rate loans

A commentator wondered why subsection (2) does not require the lender to disclose the new annual rate before it comes into effect. If the new rate is only disclosed after it comes into effect, the borrower may miss out on an opportunity to renegotiate the loan. But it should be kept in mind that non-mortgage loans are always prepayable without penalty, so the borrower is always in a position to "renegotiate" such a loan. Moreover, given the nature of an indexed rate, it might not be possible for the lender to give advance notice of the new rate to the borrower.

Section 33 Renewal agreements

The equivalent of subsection (5) in CCDA 2 would have required the disclosure statement to provide the relevant information for different renewal options that are given to the borrower. One or more commentators on CCDA 2 objected to that requirement, on the grounds that a borrower might have many options available for renewing the loan. This point was addressed in CCDA 3.2 by allowing, but not requiring, the lender to provide the relevant information for different renewal options available to the borrower. One commentator on CCDA 3.2 expressed a preference for the earlier formulation because "lenders will provide information only on options that are to their benefit resulting in biased information rather than allowing for full disclosure so consumers can make their own decisions."

I still agree with the original commentator that it is impractical to require lenders to disclose the relevant information for every option that might be available to the borrower. One cannot force a lender to offer to renew a loan on conditions that the lender does not perceive to be for its own benefit. On the other hand, lenders will have a built-in incentive to provide borrowers with attractive renewal options, because borrowers can refinance the loan through other lenders. Indeed, the main purpose of requiring the lender to provide the disclosure statement in advance of the renewal date is to allow the borrower to compare the renewal terms offered by the lender with the terms offered by other lenders.

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2018 Conference (Centennial)

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August 12 - 16, 2018