Covering old loans with new loans

In Hong Kong, it’s well known that there is a cap on the interest (48%) one can charge for loans per Money Lender’s Ordinance.

Now let’s say Mr. X needs $100. He has an apartment that is valued at approx $1000. He takes a $100 loan from an unscrupulous money lender, repayable over 10 years, at 20% p.a. secured against the apartment. The loan contains a clause that says if the borrower defaults on any payment, the whole loan including future interests would be immediately payable.

Now, the kind of person who’d take a loan from “money lenders” at 20% interest instead of “banks” is the kind who’s not particularly creditworthy. So, almost inevitably, Mr. X fails to make a payment towards the loan, let’s say 2 years later.

So, in the first year principle+interest=$100+$20, let’s say repayment is $30 second year, principle+interest=$90+18, let’s say $30 is repaid as well after the second year, principle is $78

If Mr. X defaults at this point, the remaining interest (8 years) is $78 * 20% * 8 = 124.8, so Mr. X is liable for $78+124.8 = $202.

Mr. X still has an apartment that is valued at $1000, and he doesn’t want to lose it, so the money lenders suggest Mr. X to take out another $202 loan to cover the original loan. It’s more risky for the lenders, so interest rate is now 30%.

Mr. X obviously still has to repay the loan, and given that he couldn’t repay the original $100 loan to begin with, he struggles to repay a $200 loan. After a couple months, he fails to make a payment on time again. This time he’s liable for paying $750 (the principle plus 30% interest). The money lender makes an application to court to recover $750 from Mr X, who eventually has to sell his apartment to repay the outstanding amount.

So, in less than 3 years time, the money lender lends out $100 and has an “effective” return of almost $800+

If you take a broader view, that’s pretty much a 200% effective interest rate…

Is this even legal? I pondered this question when I first heard of such stories.

And apparently it is:

HONG KONG SAI KUNG NGONG WO RESORT DEVELOPMENT LIMITED（香港西貢昂窩渡假村發展有限公司）V. TOTALCORP (NOMINEES) LIMITED [2022] HKCFA 28

””” if the parties agree that money advanced on a fresh loan on new terms will be used to pay off an old loan, they can give effect to the transaction by set-off without having to pay over the money and then take it back. The agreement can be taken at face value. But there is nothing in any of these cases to suggest that if the parties agree to vary the terms of a loan, by extending the term or changing the rate of interest, that must count as entering into a new loan. In either case, the law gives effect to what, as a matter of construction, appears to have been the intention of the parties evinced by the language they have used. If it is expressed to be a new loan, it is treated as a new loan, notwithstanding that the money was used to pay off an old loan. If it varies the terms of an old loan, the agreement will vary the terms without creating a new loan. “””

In the judgment, it seems valid for lenders/borrowers to create a new loan contract where before which the effective interest rate might exceed the statutory limit, it would not have been exceeded afterwards.

The case doesn’t directly touch upon the issue I mentioned, but if it’s allowed to create a new loan to cover an old loan and the legality of the new loan only rests on the terms of the new loan without reference to the old, then I don’t see why the situation above would be illegal.