Interest Act - 2008 Report

Section 6 of the Interest Act

[50] Section 6 of the Interest Act[31] requires a particular form of disclosure of the interest rate for certain categories of mortgage loan and provides a severe penalty for failure to comply. Section 7 restricts the lender from charging more than it is entitled under the disclosed rate.[32] The sections are as follows:

6. Whenever any principal money or interest secured by mortgage on real property or hypothec on immovables is, by the mortgage of hypothec, made payable on a sinking fund plan, on any plan under which the payments of principal money and interest are blended or on any plan that involves an allowance of interest on stipulated repayments, no interest whatever shall be chargeable, payable or recoverable on any part of the principal money advanced, unless the mortgage or hypothec contains a statement showing the amount of the principal money and the rate of interest chargeable on that money, calculated yearly or half-yearly, not in advance.

7. Whenever the rate of interest shown in the statement mentioned in section 6 is less than the rate of interest that would be chargeable by virtue of any other provisions, calculation or stipulation in the mortgage or hypothec, no greater rate of interest shall be chargeable, payable or recoverable, on the principal money advanced, than the rate shown in the statement.

Limitations of Section 6

[51] What section 6 requires is clear, although it may be of limited value. The section requires that however the lender chooses to compute its interest on a mortgage loan, it must provide the borrower with the equivalent interest rate based upon yearly or half-yearly compounding. This, one might think, could provide at least a standard mode of expression of the interest rate which could enable a borrower to conveniently comparison shop. However, two principal factors militate against the usefulness of the disclosure.

[52] First, the interest as expressed in a section 6 disclosure does not have to take into account any form of cost other than that which accrues from day to day.[33] Thus, the effect of a bonus or of various administrative[34] and service charges is completely left outside the purview of the section. This lessens the utility of the disclosure for comparison purposes. A loan with a lower stated interest rate may in fact be more expensive due to other changes. That is not something section 6 will assist the borrower to decide.

[53] Second, section 6 requires only that the disclosure be made in the mortgage itself. What the borrower has been told or discovered during the period in which he or she is deciding which loan to take or whether to borrow is not constrained by the section. The first time a mortgage borrower sees the mortgage document itself is usually in the lawyer’s office when it is presented for signature. The mortgagor is, by that time, usually committed to the transaction and may be less than interested in technical details, having made the decision some time earlier. The section 6 disclosure, therefore, has no effect on the ability of the borrower to compare various mortgage products.

[54] Apart from the possibility that it might provide a standard form of disclosure of the narrowly-construed interest rate for a loan, section 6 requires disclosure of very few of the things modern borrowers might want to know about their loan. For one thing, the concept of an equivalent rate is not one that most consumers would understand without considerable explanation. The usefulness of disclosing an equivalent rate may therefore be questionable. On other important topics, the disclosure required says nothing about prepayment options; tells the borrower nothing about renewal costs or any other costs or charges; does not require the allocation of payments in any particular way; and does not require disclosure of the term of the loan or the amortization period (if the loan is amortized). This list of omissions is only a partial one. And, if the loan is for a variable rate of interest, section 6 provides none of the safeguards that are needed to properly inform the borrower of what he or she is paying at any given time. Indeed, to comply with section 6, a table of possible equivalent rates may be included, but the section would not, of itself, require the borrower to be informed when the rate changes.

Types of Mortgages to which Section 6 Applies

[55] These objections to section 6 alone would be significant. However, an even greater challenge to the usefulness of the section arises from the description of the three forms of mortgage loan to which it applies. No case seems ever to have decided that section 6 applied to a mortgage because it was “payable on a sinking fund plan” or because it involved “an allowance of interest on stipulated repayments.”[35] Exactly when the section’s application would be triggered by these descriptions is therefore in doubt. That it has not occurred in over one hundred years would seem to suggest that it serves no useful purpose.

[56] Many laypeople would likely consider that their mortgages were representative of a the third type of plan involving “blended payments”. Common sense would suggest that this would describe a payment in which principal and interest were mixed together as is the case in the great majority of residential mortgages where a monthly payment contains some component of both principal and interest. However, case law progressively narrowed the meaning of a “blended payment” until it has come to mean only payment plans that conceal the interest charged. Exactly what this means is still unclear. It does not include any case in which payment dates and compounding dates coincide since the mathematics required to compute the amount of principal and interest is simple.[36]

[57] Whether it applies to a case in which payment is monthly and compounding is at longer intervals and in which dividing the payment between its principal and interest components requires the use of interest factors is still not entirely settled. However, the decision of the Supreme Court of Canada in Ferland v. Sun Life Assurance[37] strongly suggests that even then, unless there is an actual mathematical impossibility of separating the payments, the payment is not blended. The test of whether it was mathematically possible to separate the components of the payments was also applied in the more recent decision of Blerot v. Attorney-General of Canada.[38] In face of such uncertainty, the advice of the Saskatchewan Court of Appeal to save litigation costs and include an equivalent half-yearly rate is almost universally accepted in Canada.[39] In British Columbia, for example, the statutory form of mortgage includes a section for disclosing the equivalent rate compounded half-yearly.

[58] The lack of certainty in this narrow category has, as noted, led to compliance with section 6 (whether required or not) in all typical amortized mortgage loans. That certainly appears to be the only category of mortgage in which any scope for section 6 remains. Since most residential mortgages would fit this mold, one can conclude that section 6 is normally complied with in the consumer context. Whether it is needed in this context is another matter.

Other Disclosure Legislation

[59] The federal Bank Act[40] and a number of provincial consumer protection statutes[41] require that a borrower on a mortgage loan for personal or household purposes receive an extensive disclosure statement related to the loan, its terms and its cost, at least two days before the obligation is entered into. The disclosure statement provides much more useful and extensive information to the borrower about his or her loan than does the limited disclosure required by section 6. Most costs of borrowing have to be included in the cost of the loan. The method of disclosure of the interest rate is also highly regulated and the problem of what occurs if the interest rate is to vary over the term of the loan is extensively dealt with. The disclosure required, in short, is more useful and considerably timelier than the disclosure for section 6. For many consumer mortgagors across the country, section 6 is largely redundant.[42]

Business Borrowers and Section 6

[60] The remaining category of mortgages to which section 6 might arguably apply and which are not covered under either the Bank Act or consumer protection statutes is the business loan where the loan is amortized and payment and compounding dates do not coincide. Many commercial loans, of course, would not be of this type since amortized loans with monthly payments are less common in this market. Thus, the protection afforded by section 6 is “hit and miss” for loans to businesses. It may be argued, as legislators seem to accept in consumer protection legislation, that businesspeople do not require the protection of statutorily mandated disclosure. However, people operating small businesses and borrowing, perhaps, against their residential property for business purposes, may often not be much more sophisticated than the average consumer borrower. Is there a case for retaining section 6 to protect such borrowers?

[61] While there is arguably a case that the small business owner needs protection, section 6 as it stands does little to assist him or her for reasons already noted. It applies only to a very narrow range of mortgage loans (if it applies there); does not provide adequate disclosure to properly inform the borrower about the loan; and is not timed in a way that would allow the borrower to take any advantage from what he or she is told. Section 6 is a poor substitute for more adequate protection which would be similar to what is given consumers.

A Case for Repeal?

[62] The severity of the penalty for failing to make a needed disclosure – the loss of all interest on the loan – may explain the unwillingness of the courts to use section 6 in any robust way.[43] A more moderate approach to enforcement might have allowed some development of section 6, causing it to evolve into a more effective tool. But the debate on useful credit disclosure has become much more sophisticated in the last twenty-five years. Section 6 cannot compete with modern generation disclosure statutes. Given its restrictive, almost accidental application and the shortcomings of what it provides, the preliminary view of the working group would be to recommend outright repeal.

[63] However, since the disclosure of the semi-annual rate has become the standard mode of expression of the interest rate in most amortized mortgages, we recommend consultation with lenders and real estate lawyers as to whether the repeal of sections 6 and 7 would negatively affect established practice. If there is a reluctance to repeal a section that has become so enshrined in Canadian mortgage lending practice, an alternative would be to amend section 6 so that its application to the typical amortized mortgage is clear. In the next phase of this project, the working group will also consult possible amendments to section 6 as an alternative to repeal.[44]

[64] The question might also be asked whether section 6 should rather be turned into effective disclosure legislation, mirroring that adopted in many provinces. We do not recommend this course of action. We consider that there would be little point in increasing the complexity of the varying disclosure schemes that now exist by adding another federal level to them. Rather, provinces might be asked to reconsider whether the small business borrower is not in need of protection comparable to the consumer and to make further efforts at establishing uniformity among themselves in their credit disclosure legislation and its coverage of mortgage loans.

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