When it comes to an event of mortgage default, Lenders may be surprised to find that Section 8 of the Interest Act prevents them from charging higher rates of interest on default of a mortgage. They may also be surprised to find that the provisions made in their loan agreements for mortgage default penalties, fees, or fines, are rendered unenforceable due to the effect of Section 8 of the Interest Act; that is, if such penalties, fees, or fines have the effect of raising the interest rate of the mortgage on default. This is notwithstanding the prior knowledge of Borrowers of the inclusion of such penalties in their loan agreements, and their execution thereof.

The Courts have, on many occasions, set aside interest rate increases triggered by default, as well as default penalties and late payment charges which did not reflect real costs incurred by the Lender.

In Krayzel Corp. v. Equitable Trust Co., 2016 SCC 18, the Supreme Court of Canada (SCC) clarified Section 8 of the Interest Act, stating that increases in interest rates that are tied to an event of default are prohibited; however, increases in interest rates due to a passage of time (e.g. loan agreements stipulating an increase in interest rate at a certain known date during the term) are not prohibited. The SCC also clarified that loan agreements which provide for interest rate discounts if the loan is repaid on time are also likely not prohibited by Section 8.

In P.A.R.C.E.L. Inc. v. Acquaviva, 2015 ONCA 331, the Court set aside a number of late payment charges and default fees in its decision, stating that they were prohibited under Section 8 of the Interest Act, because they did not involve “actual losses as a result of late or missed payments under the mortgage”. This means that the Lender has to incur real costs, administrative or otherwise, in its attempt to recover the unpaid debt.

Some important takeaways for Lenders are as follows:

1. Interest rate increases on a mortgage triggered by default are prohibited;
2. It is likely that interest rate increases which are stipulated by a certain date, not related to default, are not prohibited;
3. Default penalties and late payment charges have frequently been disputed by Borrowers, and set aside by Courts. Fees charged must reflect actual losses incurred by the Lender.

For Lenders wishing to minimize the possibility of disputes with their Borrowers, it would be prudent to take heed of the Court decisions surrounding Section 8 of the Interest Act when drafting their mortgage provisions.