The vast majority of mortgage loans are wholly variable at the
lender's discretion. But are they?
Let's assume the lender's variable rate starts out
100bps above cash rates. Over the term, the lender increases the
interest rate to cash rates plus 500bps. You would probably readily
agree that the lender has acted improperly, and you probably
suspect that a court would consider that this change is
unconscionable. Presumably, therefore, whether a lender can change
a variable rate depends on whether the change is reasonable. How
can this reasonableness be assessed?
In a UK case Nash & Ors v Paragon Finance Plc 
EWCA Civ 1466 (15 October 2001) (click here to read), the
borrower argued that there should be implied into a loan contract
for a variable rate loan a provision that:
the rate would not be adjusted otherwise than in accordance
with an adjustment made by comparable lenders
the rate should only be adjusted in accordance with cash
the rate should not be varied arbitrarily, capriciously or
The court dismissed the first two arguments but upheld the
third. The court said that it was clear that there must be some
restriction on the mortgagee's ability to vary interest rates.
It followed that the rate could not be adjusted arbitrarily,
capriciously, or unreasonably.
Perhaps another way to put it is that there is an implied term
that a lender will not adjust the interest rate, to an extent that
no reasonable lender would have raised it.
To give effect to the reasonable expectations of the parties,
the court said that it was necessary there be an implied term that
the rates of interest are not set dishonestly, for an improper
purpose, capriciously or arbitrarily. There was an implied term
that the lender must not set rates of interest unreasonably.
In the particular case, the rates started out about 2% above
building society rates and ended up about 7% above. It was
important that the court found that the lender did not act
capriciously against this particular borrower, or this particular
class of borrowers. It is reasonably clear that if a lender
selected an individual borrower or small groups of borrowers and
increased their rates, such action is likely to be unconscionable.
In this case, the court held that there was no capriciousness of
that kind, and the lender increased its rates purely because of
commercial considerations and these changes affected all borrowers.
The lender had encountered financial difficulties and it felt
obliged to raise the interest rates paid by its borrowers, acting
in no way dishonestly.
The court held that it should only intervene where a bargain is
grossly unfair to the borrower. Increasing the interest
rate in this case did not contravene the ordinary principles of
In Australia, in respect of loans regulated by the UCCC, the
court can cancel or reduce a change to interest rates if the court
considers the change is unconscionable. In respect of loans
governed by the Code of Banking Practice, banks must act fairly and
reasonably towards their customers in a consistent and ethical
manner, and this provision implied into all contracts may provide a
further basis to complain about unilateral interest rate
Tip 1 – Do not vary interest rates that effect only
one borrower or a small group of borrowers
Tip 2 – Maintain records of why an interest rate
change is required, particularly if your interest rate change
exceeds market fluctuations.
Many credit contracts contain provisions entitling lenders to
vary any term and to vary fees and charges and introduce new
charges. While such provisions are extremely common, it would be
unwise to take them at face value. Usually these rights are
exercised honestly in good faith and the change will be enforceable
against the borrower. However, if those rights are exercised
arbitrarily, capriciously or unreasonably, it is likely that a
court will not enforce the change.
In the years following the global financial crisis of 2008 many Australian investors lost their life savings as financial products failed and the Australian Stock Exchange shed over 3,000 points.
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