Higher Interest Rate Triggered by “Time,” Not “Default,” Court Confirms

In a recent case, a mortgage lender was successful in having the Divisional Court re-confirm its entitlement to an 18% interest rate on the final month of the mortgage’s term. This followed the Court’s conclusion that the lower court judge had erred in declaring the interest rate formula unenforceable for being in breach of s. 8 of the Interest Act.

The lender and borrowers entered into a commitment and mortgage arrangement for $3,800,000. It was duly registered against a commercial property and had a term of seven months. The stipulated interest rate was 8.25% per annum for the first six months, and then 18% per annum after that, unless the mortgage was renewed or discharged.

The borrowers supplied seven monthly cheques for over $26,000 each, but the second and third cheques bounced. They paid the interest portion of the payments for the first three months, but then the next few months’ worth of cheques were returned NSF as well.

The lender concluded the borrowers were in default and promptly issued a notice of sale. On the expectation that it was now entitled to 18% interest after the 6-month mark of the term, the lender prepared its mortgage discharge statement accordingly.

The borrowers disagreed with the lender’s calculations and brought a motion before a judge, under the provisions of the Mortgages Act, to determine the correct amount still due under the mortgage, including the accrued interest. In that ruling, the judge held the interest rate arrangements were contrary to s. 8 of the Interest Act, and declared them unenforceable.

The lender appealed the motion judge’s decision to the Divisional Court, arguing that the judge had misinterpreted the agreement and had used the wrong approach to the interest rate calculations for the final month of the 7-month term.

The Divisional Court agreed; the interest rate formula was not in breach of s. 8 of the Interest Act. That provision merely prohibited an imposed fine, penalty, or interest rate that has the effect of increasing the charge on arrears beyond the interest payable on principal money not in arrears. That was not the scenario here: The increased interest rate was not triggered because the borrowers defaulted in repaying the principal when it fell due; rather, the increased rate was triggered by the passage of time at the end of the sixth month of the term, in circumstances where the borrowers did not renew or discharge the mortgage before the term’s final month (as they could have). The interest rate before and after the default was the same – and thus there was no engagement or breach of s. 8 of the Act at all.

The court added that this approach aligned with prior court-approved scenarios of a similar nature. For example, if a first loan agreement establishes one rate of interest that applies for most of the loan’s term, and then a second, higher rate becomes effective in the final month of the term, this is also not considered a breach of s. 8 of the Act. Instead, this kind of “scheduled” increase (that is not otherwise tied to the occurrence of a default), is a legitimate way for lenders to obtain a higher rate of interest without breaching s. 8, as long as the effect of the provision does not impose a higher rate on arrears than on money not in arrears.

The Divisional Court granted the appeal accordingly and confirmed that the lender was entitled to 8.25% interest for the first six months of the mortgage term and 18% for the seventh month, and thereafter. See: Alleghe Mortgage Fund Ltd. v. 1988758 Ontario Inc., 2021 ONSC 4887; and 2021 ONSC 5186.

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