The Credit Application Says Interest On Overdue Accounts Is 2% Per Month..Why Can I Can Only Collect 5% A Year?

Clients often come to us with a credit application and want to know why they cannot collect interest at the rate specified in their contract.  The contract explicitly states a monthly interest rate, so what is the problem?

The Canada Interest Act imposes specific requirements on contracts, including credit agreements.  Contracts must disclose the interest rate as an annual rate.  If an agreement doesn’t specify an annual rate, then the interest rate is fixed at 5% per year.  This 5% rate applies even if a different rate is specified in the contract, but at an interval of anything other than one year.  For example, if a contract only specifies a monthly rate, then the interest rate in the contract has no effect: the Interest Act imposes an annual interest rate of 5%.

Also, a customer who has been paying interest for some time under a credit agreement that does not comply with this requirement may set off the excess interest—the amount above 5% per year—against the outstanding principal.

There are two methods of calculating an annual interest rate: the “nominal” interest rate is simply twelve times the monthly rate; and the “effective” interest rate includes the effect of compound interest, to more accurately reflect the amount of interest paid in one year. Either method satisfies the requirements of the Interest Act.

To avoid unexpected the effects of the Interest Act, make sure all of your contracts comply with the disclosure requirements. Even if monthly interest payments are intended, the equivalent annual rate must be specified.

Allan Elliott is a lawyer and partner at Pushor Mitchell, LLP having a civil litigation practice in Kelowna, British Columbia.  Mr. Elliott has 30 years of experience in civil litigation matters including commercial credit disputes. He can be reached either by telephone at (250)869-1105 or by email at [email protected]

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