Short-term loans have high interest rates, at least 8% pa. They have high loan fees, and often require the interest to be paid up front.
They are risky for borrowers because the high interest rate quicky eats away the equity in the property, and if they default, the interest rate jumps to 16% pa or more.
They are risky for lenders because the court may re-write the loan by reducing or eliminating interest, if the loan is secured by the borrower’s home and if no background checks are carried out on the borrower to ensure that the borrower is able to afford the repayments.
Two recent Court decisions show that short-term loans secured by residential property can be risky business for lenders.
The Courts found that the loans were unconscionable and ordered that the loan interest and charges were not recoverable. Only the amount advanced needed to be repaid. In one case all interest was eliminated, and in the other, the interest rate was reduced to 4% pa.
The first case was Stubbings, which was decided by the High Court of Australia. The High Court found that the lender acted unconscionably, that is, against good conscience, for these reasons:
- The loan was a 12 month loan secured by mortgage over a residential property in the personal name of Stubbings. It was his home.
- The loan required regular monthly repayments, but Stubbings had no job or income or cash on hand to make the repayments, and inevitably defaulted after only 2 months.
- The lender did not ask for any financial information from Stubbings, but relied only on the value of the property in lending 70% of the value.
- The Court found the lender was exploiting Stubbing’s desperation for a loan, and that the loan was a scheme to absorb the equity, by charging interest at 10% pa (the default rate was 17% pa), and then forcing the sale of the property to recover its loan.
The punishment was that the borrower needed only to repay the principal, and not the interest and extra charges.
For more, see my case note
The second case was Creatrix, which was decided by the Supreme Court of NSW. For similar reasons, the Supreme Court ordered that lender’s interest rate be reduced from 69.5% pa to 4.1% pa, when the principal was repaid.
For more, see my case note