May 25, 2009

Penalties assessed due to mortgage contract cancellation. Are they valid or ultra vires?

Financial institutions have many mechanisms to discourage borrowers who wish to benefit from the current low interest rates.
Borrowers wishing to terminate their mortgages are now facing several obstacles even though there exists a law that limits a penalty for a breach of a mortgage contract to three months interest.

Le Journal de Quebec has found that Canadian banks and The Desjardins Group have gradually changed their practices and methods of calculating mortgage penalties. These changes are coming as a result of the rising number of customers who want to break their mortgage contracts so as to benefit from the lower interest rates. The change in interest rates from 6% of a year and a half ago to a 3.75% rate today could save a client almost $19000.00 on a $250,000.00 over a 5 year term .

The banks have established a practice of charging either the 3 month penalty, or a system of calculations which would determine the loss of revenue, between the higher interest rates at the time of signing, and the rates which are in force today, whichever amount is greater.

In addition, banks and credit unions also require borrowers to repay the money received in the way of cash credits, discounts in interest rates, notarial fees, and other gifts they received at the signing of the mortgage deed.

The law says?

According to Professor Jacques Deslauriers, Faculty of Law, Laval University, in Article 10 of the Act, interest is that which determines the parameters of the compensation payable upon termination of a mortgage.

“This article says that the maximum penalty for breach of contract mortgage exceeding five years may not exceed the equivalent of three months interest on the contract,” says Jacques Deslauriers, Professor in the Faculty of Law at Laval University. Law contracts difficult to understand are why banks and credit unions are capable of imposing harsher penalties.


His colleague Marc Lacoursière, also professor of Law at Laval University, adds that the Supreme Court has settled the issue in a ruling in 1986 (Royal Trust v. Potash Ben).

According to him, financial institutions have no right to raise the amount of the penalty to more than three months interest for early repayment of a mortgage.

However, this law applies to holders of a mortgage  that has been extended five years from the original date, in the same financial institution.

Borrowers who are in their first mortgage, less than five years, can not rely on this provision. They have no other choice but to abide by the terms of their act and other banking documents they signed

*( I have just been contacted by Marc Lacoursière Professor of Law at the University of Laval Faculty of Law on behalf of himself and his colleague Jacques Deslauriers also a Professor of Law at Laval University Faculty of Law. They felt that due to to great amount of people contacting their banks to break their mortgages, they should clarify their comments and expand upon the statements  for which they were quoted in the Journal de Quebec on May 2nd and subsequently in my above post of May 25th.).

Saturday 2 May 2009, the Journal de Quebec published an article on the mortgage refinancing entitled “ Attention aux attrapes ! ‘for which we were interviewed on the scope of Article 10 of the Interest Act. This section of the Act provides that after a period of five years from the original date, with a maximum penalty of three months interest on capital not repaid, the borrower may prepay. Having learned that many borrowers had applied to their financial institution for this purpose, we wish to clarify the following points, as the issue of penalties and interest due because of early repayment is complex and involves several nuances.

First of all, to take advantage of Article 10 of the Act, interest and repayment of a loan in advance of its contractual conditions requires a payment of a penalty of up to three months of interest. A borrower (ie. An individual and not a legal person) must in fact wait more than five years from the date of the mortgage contract. If this loan is paid prior to to  five years, the borrower is bound by the terms of his contract which may provide for even heavier penalties.

Borrowers should read their mortgage contract very carefully, and determine the original date of the mortgage to calculate the starting point of  the five year period to be able to rely on Article 10 of the Interest Act ‘.

 In principle this is the date of signing the mortgage deed, however, upon renewal of the mortgage contract, many contracts provide that the original date of the mortgage is the signature of the new mortgage (also called “renewal agreement”). The borrower must again wait  a period of five years from the date of signing of this renewal agreement to repay the loan and renew the conditions deemed most advantageous to benefit from the limitations of the penalties in terms of interest, under Article 10 of the Interest Act.

Secondly, although a penalty for early repayment (and thus the breaking of the mortgage contract) is limited to three months of interest, a financial institution can claim certain costs of administration: processing the application, notary fees , assessing the credit worthiness of the borrower and, in the case of early redemption, some closing fees. Furthermore, a financial institution is usually allowed (not considered abuse) , to recoup any interest rebates or discounts given the borrower when the loan was granted. (eg a rebate or discount of interest of 1.5 or 2 %)  if the borrower breaks the contract prior to the expiration of the agreed five year term in favour of going with another financial institution.

That is to say that breaking a mortgage contract to refinance at a cheaper rate, the borrower must assess the penalty costs that may be charged. It is generally not profitable to do so if the cheaper rate is less than 1- 2 % lower than their current rate.


Jacques Deslauriers

Marc Lacoursière

Professors of Law

Laval University


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