The general commercial practice for lenders is to include a contractual term imposing a greater interest rate if the loan goes into arrears. This is both an incentive and a deterrent. The borrower is motivated to keep the loan from defaulting and is, therefore, more likely to pay on time to prevent the increased interest clause coming into effect. This practice is, however, regulated by legislation. How that impacts mortgages is highlighted in a recent case of the Superior Court of Justice in Ontario (ONSC) indexed as Benson Custodian Corporation v. Situ et al (2019).
The mortgage in question was placed on residential property in Toronto. The landowner/mortgagor was in default and the mortgagee would not extend or renew. The mortgagor had obtained financing to pay out the mortgage, but the lender resisted. The lender wanted to charge an extra three-months of interest because of the default. There were also collection charges added to the total mortgage debt. The mortgagee brought a motion for summary judgment.
The mortgagee relied on the mortgage contract which specified the following:
In addition, on the issuing of a Notice of Sale or filing a Statement of Claim, the Mortgagee(s) shall be entitled to collect as liquidated damages from the Mortgagor(s) a sum equal to the payment of three (3) months’ interest on the principal amount outstanding.
The Mortgagor’s Position
17 (1) Despite any agreement to the contrary, where default has been made in the payment of any principal money secured by a mortgage of freehold or leasehold property, the mortgagor or person entitled to make such payment may at any time, upon payment of three months interest on the principal money so in arrears, pay the same, or the mortgagor or person entitled to make such payment may give the mortgagee at least three months’ notice, in writing, of the intention to make such payment at a time named in the notice, and in the event of making such payment on the day so named is entitled to make the same without any further payment of interest except to the date of payment.
8 (1) No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by a mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.
Mortgages Act Result
The Mortgages Act provides that a mortgagor in default can pay three months’ interest on the principal in order to cure the default. However, once the mortgagee takes steps to enforce the mortgage, they are only entitled to the interest due under the mortgage to date and not an additional three months of interest. The section has been interpreted to be one for the benefit of the mortgagor. It does not impose a three-month extra interest obligation on the mortgagor unless the mortgage terms call for such a payment. In other words, the obligation must be found in the mortgage itself and does not arise under section 17 of the Mortgages Act. As that obligation was contained in the mortgage here, it could be enforced.
Interest Act Result
The Interest Act does not deal with the size or severity of the obligation and prohibits such penalties outright. Here, the clause in the mortgage clearly has the effect of increasing the charge on the arrears. This was not a case of the mortgagor seeking to pay out the mortgage before it was due for which there is a three-month penalty for that privilege. The three-month penalty was not recoverable.
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