In Ontario’s highly active mortgage enforcement landscape, private lenders, Mortgage Investment Corporations (MICs), and institutional mortgagees are increasingly relying on default fees, administrative charges, and renewal fees to protect their yields and recover operational costs. However, lenders must be mindful of the fine legal line between a legitimate administrative charge and an illegal penalty.
Under Section 8 of the federal Interest Act, any charge that has the effect of increasing the cost of a mortgage purely because a borrower has defaulted is strictly prohibited. As Ontario courts increasingly scrutinize payout statements prepared by lender during Power of Sale and foreclosure proceedings, understanding how to structure fees—especially mortgage renewal fees—is critical to ensuring enforceability and avoiding costly litigation.
The Legal Framework: Section 8 and the “Substance Over Form” Rule
Section 8(1) of the Interest Act states that no fine, penalty, or rate of interest can be stipulated for, taken, or exacted on any arrears of principal or interest that has the effect of increasing the charge on those arrears beyond the interest rate payable when the mortgage is in good standing.
The Supreme Court of Canada clarified the definitive standard for this rule in Krayzel Corp. v. Equitable Trust Co. The court decided that when determining if a fee violates Section 8, substance must prevail over form. It does not matter how creatively a clause is drafted; if the practical effect of the provision is that the borrower pays more because they defaulted, the clause and/or the fee is void as it will be deemed to be a penalty.
This rule applies to two major categories of lender charges:
1. Administrative and Default Fees
The Ontario Court of Appeal decision in P.A.R.C.E.L. Inc. v. Acquaviva established that standard default fees, late payment charges, and administrative penalties violate Section 8 unless the lender can prove the fee reflects real, out-of-pocket costs actually incurred. If a lender charges a flat $500 “default fee” simply because a payment was missed, without showing $500 worth of actual administrative or legal expenditures, the court will strike it down as an illegal penalty.
2. Automatic Renewal Clauses
A common operational trap involves “automatic renewal” or “deemed extension” provisions. In cases like Cheung v. Moskowitz Capital Mortgage, the mortgage terms stated that if the principal was not repaid at maturity, the mortgage would automatically extend for six months, triggering an immediate 5% renewal fee and a 3% interest rate hike.
The court struck this down. Because the trigger for the fee and the interest spike was the borrower’s non-payment of principal at maturity (an event of default), the automatic renewal was deemed a thinly veiled penalty explicitly designed to circumvent Section 8.
How to Structure Renewal Fees Legally
Lenders do not have to forfeit their ability to charge renewal fees or increase interest rates as a mortgage nears maturity, but the mechanism must be tied to the passage of time, not the occurrence of a default.
The Passage-of-Time Exception
The Supreme Court in Krayzel unanimously affirmed that a step-up interest rate or a scheduled fee tied strictly to a calendar date is completely lawful. If a mortgage agreement states that the interest rate is 8% for the first 11 months, but automatically steps up to 12% in month 12 and remains 12% thereafter, this does not violate Section 8. The higher rate applies whether the borrower is in default or not; it is driven entirely by time.
To safely structure a renewal fee without triggering Section 8, lenders should utilize one of two frameworks:
Option A: Lenders should make best efforts to avoid including automatic renewal clauses that are triggered by virtue of the borrower failing to make payment on the maturity date. Instead the mortgage commitment or loan agreement ought to include a provision that speaks to renewal at mutually agreed upon terms. Therefore upon the maturity date the borrower and lender will be required to enter into a renewal agreement whereby the Lender can demand a lender fee and/or increase the interest rate from the previous month.
Option B: In the alternative, the Lender can draft the loan agreement in a manner whereby a step-up in the interest rate is triggered by virtue of the passage of time and as a result of the borrower failing to repay the loan upon maturity. For example: “The interest rate shall be 8% from inception until August 1. From August 2 onward, the interest rate shall be 12%.” If maturity is August 15, the rate increases naturally due to time, meaning the post-maturity rate is identical to the pre-maturity rate, perfectly satisfying Section 8.
Best Practices for Lenders to Avoid Legal Trouble
To insulate an enforcement file from Section 8 challenges by borrowers’ counsel, institutional and private mortgagees should implement the following operational safeguards:
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Characterize Fees as “Bona Fide Pre-Estimates of Damages”
When drafting mortgage commitments and schedules, ensure that administrative, enforcement, and NSF fees are expressly characterized as a “genuine, reasonable pre-estimate of the actual administrative damages and overhead costs incurred by the lender.” As seen in 1539339 Ontario Inc. v. First Source Financial Management Inc., this explicit language significantly aids collectability, provided the fees remain proportionate and are in fact found to be reasonably incurred by the Lender.
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Maintain an Incurred-Cost Ledger
Never charge arbitrary “bonuses” or rounded enforcement fees that cannot be backed up by paperwork. If you charge a fee for property inspection, file corporate reviews, or non-legal default management, ensure your corporate ledger tracks the actual time spent or third-party invoices received. Under the P.A.R.C.E.L. framework, if a borrower challenges the ledger, you must be prepared to prove the costs were real.
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Eliminate “Prompt-Payment” Discounts That Mask Penalty Rates
Avoid structuring clauses that offer a high interest rate with a “discount” for paying on time (e.g., “Interest is 18%, but reduced to 10% if paid on the first of the month”). Krayzel explicitly established that courts will treat the loss of a discount upon default as a Section 8 penalty, rendering the higher rate entirely unenforceable.
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Provide Proactive Options at Maturity
If a borrower cannot redeem at maturity, do not let the file sit in limbo while relying on a predatory default interest rate to accumulate equity. Either formally execute a short-term extension agreement with an agreed-upon extension fee, or immediately issue a Notice of Sale under the Mortgages Act to begin formal enforcement while maintaining the original, lawful interest rate on arrears.
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