Our position was accepted: Default interest - an incentive for payment, not a punishment

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For years, ACRI and the Clinic for Human Rights at the University of Haifa have argued that the Israeli interest rate mechanism is outdated and infringes on the rights of debtors, violating their dignity and property. The position papers we submitted, explained by attorneys Debbie Gild-Hayo and Reut Cohen from the ACRI and the Clinic, respectively, assert that the purpose of penalty interest is to incentivize people to pay on time, but this incentive does not work for debtors who lack the financial ability to pay the debt. In such cases, the interest serves only a punitive purpose, akin to a 'tax on poverty.' It was also argued that when a debtor begins to repay the debt according to a court-ordered installment plan based on their ability, there is no logic in continuing to accrue penalty interest, as its purpose has been achieved.

On April 4, 2022, the Ministerial Committee for Legislation approved two bills aimed at making a significant reform regarding interest rates and default. It was proposed to change the name of the interest to default fees, clarifying that its purpose is to incentivize the debtor to pay on time. This change is not only semantic but substantial, as it signifies an understanding that this is not interest belonging to the creditor or intended to compensate them. Most importantly, it is not interest designed to punish the debtor.

The most significant change will take place in practice: proposed default fees will cease to accumulate when the debtor starts to pay according to the court-ordered installment plan based on their financial ability. This change reflects the understanding that indigent debtors should not be punished by having their debt continuously increase even when they are making payments. Furthermore, the proposed bills aim to expand the authorities of administrators and registrars in implementing reduced default fees, with the goal of encouraging debtors to pay according to their ability, ultimately leading to debt closure rather than inflation.

Last week, the Knesset passed two amendments to the legislation on second and third readings. In line with our comments, significant changes were introduced, turning default fees from a punitive component into an incentivizing one: the fees will be lower; they will be suspended for debtors meeting their payment plan; they will no longer accumulate as compound interest to prevent excessive debt inflation; and they will be added at defined intervals rather than on a daily basis. Thus, a debtor who adheres to their payment plan will have default fees completely suspended, reducing them by about 70%. Debtors struggling to meet the plan will also receive a significant reduction in the default fees.