Those of you who have mortgages may know that the federal Interest Act contains a section that expressly governs post-default mortgage interest rates. Specifically, Section 8 of that act prohibits a lender from imposing a “fine, a penalty or a rate of interest” that has the effect of creating a higher charge on unpaid arrears than would be imposed on principal money not in arrears.
In plain language, this means that a lender cannot demand that the borrower pay a higher post-default rate of interest as a penalty or fine for going into default.
A recent Supreme Court of Canada decision, Krayzel Corp. v. Equitable Trust Co. tackled an interesting related issue: Does this prohibition also cover those scenarios where the borrower gets a lower-interest rate “discount” while he or she is not in default, as compared to the higher rate payable if the loan goes into default?
The issue arose in relation to a mortgage that prescribed a defined “interest rate” of 25 per cent that took effect only if the borrower went into default. That threshold was triggered by (among other things) a failure to make set payments at a stipulated lower-interest “pay rate”, which was likely to be around 7.5 per cent. Essentially, the lower “pay rate” was to serve as an incentive to the borrower for paying promptly.
The borrower made some payments but went into default. The lender claimed that this triggered the provision allowing for 25 per cent interest to be charged for arrears during the post-default period.
The Supreme Court was asked to rule on the validity of these mortgage provisions. It had to consider the proper interpretation of the mortgage, assessing the intention of the parties and reviewing the meaning and purpose of the legislation itself.
The court ultimately held that the “discount” provision was void under Section 8 of the act. As far as that prohibition was concerned, there was effectively no distinction between a higher-interest “penalty” for default and a lower-interest “discount” for punctual payment – they both made it more costly and difficult for borrowers who were in default. There was no justification for differentiating between the two, in light of the overall intent of the Interest Act, which was to protect landowners from charges that would make it impossible for them to redeem or protect their equity.
The court also noted that the lender’s use of (possibly) misleading terms like “bonus”, “discount” or “benefit” do not change the legal outcome. The validity of the mortgage provision is determined by its substance, not its form.
Returning to the mortgage at hand, when it was boiled down to its essence, the arrangement offered by the lender in this imposed a 25 per cent interest rate on arrears, as compared to 7.5 per cent interest on principal money not in arrears. This put it squarely within the wording of the Section 8 prohibition in the act. The court accordingly voided the 25 per cent interest provision and set it at 7.5 per cent or prime plus 5.25, whichever was higher.