Prepayment Penalties in Canadian Mortgage Law

University of Western Ontario Journal of Legal Studies, Forthcoming

30 Pages Posted: 17 Mar 2015  

Peter S. Spiro

University of Toronto - Mowat Centre for Policy Innovation, School of Public Policy and Governance

Date Written: March 16, 2015

Abstract

Mortgages provided by Canadian banks impose prepayment charges of at least three months' interest if the mortgage is paid off before it expires. That charge is imposed even if the bank profits from the mortgage being repaid early, as would be the case when market interest rates have risen. This is a one-sided term that appears to reflect an imbalance of bargaining power between lenders and borrowers.

The most common reason for prepaying a mortgage is that the property is being sold. The standard mortgage terms also include a "due on sale" clause that frequently triggers prepayment charges. The bank purports to be able to prevent the borrower from selling the property without first paying off the mortgage. The existing mortgage cannot be assumed by a new purchaser without the lender's approval, and it can arbitrarily withhold that approval. Given their large diversified portfolio of mortgages, and the other remedies available, banks do not require this degree of control from a risk perspective. Their main motivation for inserting the clause is likely to be the increased profits generated by prepayment charges.

Even though almost all mortgages contain this clause, there has not been a single reported case in Ontario, since 1960, of a lender attempting to sue a borrower for breaching this term. This raises a suspicion that they have overlooked breaches because they are not confident of its enforceability. Applying the principles of equity to the mortgage contract suggests that it ought not to be enforceable. Legislation should be amended to clarify this situation for the benefit of borrowers.

Keywords: mortgage law, contract law, unconscionability, consumer protection, banking

JEL Classification: K12, G21, D18

Suggested Citation

Spiro, Peter S., Prepayment Penalties in Canadian Mortgage Law (March 16, 2015). University of Western Ontario Journal of Legal Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2579470

Peter Spiro (Contact Author)

University of Toronto - Mowat Centre for Policy Innovation, School of Public Policy and Governance ( email )

720 Spadina Avenue, Suite 218
Toronto, Ontario M5S 2T9
Canada

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