MORTGAGE INTEREST — PITFALLS TO AVOID
The potential pitfalls created by the Interest Act (Canada) are avoidable so long as you’re aware of them. Let’s look at them.
Annual Rate — Section 4
The first pitfall is to stipulate interest at, say, “2% per month”. Section 4, where it applies, requires that wherever any interest is, by a written contract, made payable at a rate per day, week, month or any rate for any period less than a year, no interest beyond 5% per annum is chargeable unless the contract contains an express statement of the yearly rate to which the other rate is equivalent. In short, you should not express interest at, say, “2% per month” but rather express it as “24% per year, calculated monthly”. Section 4 does not apply to mortgages on real property.
It may be difficult to express interest at a rate per annum, such as where interest fluctuates with the “180-day London Inter-bank Euro Dollar Offer Rate” (“LIBOR”), where interest is based on a 360-day year (similar to U.S. loans). To ensure compliance with Section 4, certain statements, depending on circumstances, should be added, such as stating that the yearly rate to which the LIBOR rate is equivalent is the LIBOR rate multiplied by the actual number of days in the year, divided by 360.
Blended Payments — Section 6
Section 6 requires that where payments of principal and interest are “blended”, the mortgage must state the interest chargeable on principal calculated yearly or half-yearly, not in advance. Failure to do so results in no interest at all being chargeable. (Most lenders choose to stipulate interest calculated “half-yearly” rather than “yearly” because it yields more interest.)
As to interest bonuses, the courts traditionally have held that so long as the mortgage on its face does not refer to the bonus, then Section 6 is not triggered.
Floating rates can be a problem under this Section. However, there are various ways to comply, depending on the circumstances, including: setting out in the mortgage the formula on how to compute the equivalent rate, calculated half-yearly, not in advance; adding a schedule setting out the equivalent rate (calculated as required) for a range of given interest rates; provide an amortization schedule setting out the amount of principal and interest for each mortgage payment (together with a provision that the lender may deliver similar, binding, schedules whenever the floating rate changes); or, some combination of these approaches.
As a back-up, it is advisable, in addition to the Section 6 statement, to stipulate that the installments of principal and interest are to be applied first to interest and the balance to principal outstanding and make the payment and calculation period the same (to help assert that the payments are not “blended”).
Demand mortgages generally are not subject to Section 6 because they typically do not require principal and interest to be paid in blended payments.
Penalty Interest — Section 8
Section 8 provides:
(1) No fine, penalty or rate of interest shall be stipulated for … on any arrears of principal or interest secured by mortgage on real property that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.
This Section applies to mortgages where, for example, the interest rate is doubled if there is a payment default of principal or interest. This Section is not limited to interest, but includes fines and penalties, such as a bonus of three months’ interest on default or if enforcement proceedings are taken.
Section 8 can apply, however, in less obvious ways, for example to compound interest: if
interest is calculated and compounded half-yearly, do not stipulate for interest after default to be
The more surprising and troublesome problem, however, with Section 8 is with interest-free loans, where the parties, for good business reasons, agree that a loan will be interest-free but if the debtor fails to pay it when due, a reasonable interest rate will then apply. The Ontario courts, however, have struck down such agreements and various attempts to get around the problem, such an by stipulating that interest is waived or reduced if the principal amount is punctually paid when due.
Courts in some other provinces, however, have differed with the Ontario approach and have taken a less literal view of Section 8. Those courts have held that the Section does not apply where the parties, for good business reasons, agree that a loan will be interest-free but, if the debtor fails to pay it when due, a reasonable interest rate will then apply. Those courts have held that such provisions are not contrary to Section 8 because Section 8 is aimed at preventing a lender from exacting an excess profit merely because of default and to apply the Section to such a no-interest loan would be unjust and inequitable to the lender. Unfortunately, this is not the law in Ontario.