By: Ray Mikkola (Mississauga Business Times)
You have may have noticed a few weeks ago that some banks were offering closed mortgages for a 5-year term at the unprecedented low interest rate of 2.99%. I found the 10-year mortgage offering, albeit at a higher rate of interest, even more remarkable.
And that’s not all.
The federal government recently enacted new regulations that affect prepayment rights which will significantly impact commercial mortgage lending in Canada.
For all new commercial mortgages made after January 1, 2012, mandatory prepayment rights after the initial 5-year term will no longer apply where the borrower is a partnership or a business or a commercial trust.
Most lenders and businesses welcomed the change, noting that it was long overdue.
The new regulations were made under the federal Interest Act that deals with consumer protection as well as exceptions to those protections. In the case of commercial mortgages, the removal of these protections is intended to allow a commercial borrower more flexibility in negotiating directly with lenders.
The thinking behind the new regulations is twofold. The new regulations are intended to reflect a new commercial reality: business enterprises are now structured in a variety of ways. And sophisticated businesses (whether corporations or not) should be able to negotiate their own commercial mortgage terms. You get what you negotiate.
Mortgages to individuals and commercial enterprises come with different protections to borrowers.
Mortgages to individuals are open after five years—meaning you can prepay the mortgage by paying off a lump sum—upon payment of not more than three months of penalty interest. This is known as the 5-year provision and is a form of consumer protection. Individual borrowers cannot waive the prepayment right.
By providing these mandatory prepayment provisions, Parliament provided individual borrowers with the ability to renegotiate long-term, high-interest mortgages without having to pay unreasonable penalties imposed by lenders, calculated on the basis of a term longer than five years.
On the commercial side, however, corporations didn’t (and still don’t) qualify for this protection. Even before the new regulations were in effect, commercial mortgages to corporations could be “closed” for any number of years.
But, arguably, these corporate borrowers could negotiate long-term mortgages on more favourable terms than could, say, a borrower who happens to be a partnership, because the corporate borrower could bind itself to a closed mortgage without being entitled automatically to prepay after five years whereas the partnership borrower could not waive the prepayment right.
So, the important point about these changes is that, before the changes came into force, enterprises not structured as corporations or joint stock companies sometimes had trouble in securing long-term financing for two reasons. First, prepayment terms were prescribed by the Interest Act and could not be waived. Secondly, some lenders were unwilling to advance funds with a prepayment penalty limited to just three months interest, at least not without requiring a higher rate of interest.
From a lender’s standpoint, remember that lenders count on income streams from their loans. If interest rates were to fall further in coming years, those same lenders presumably could not reinvest prepaid mortgages to get the same rate of return.
Three months of interest simply may not be adequate compensation to a lender for the “breakage” costs associated with prepayment of, for example, a 10-year loan after just five years.
Whether the new regulations will result in more opportunity for non-corporation businesses to borrow on more favourable terms remains to be seen. Salute optimism. Await evidence.
Ray Mikkola is a senior partner of the Commercial Real Estate Practice at Pallett Valo LLP, Mississauga’s largest business law firm. He can be reached at email@example.com or (905) 273-3022, ext 276