Illinois Appellate Court Upholds Default Interest Clause in Mortgage Note

On March 19, an Illinois Appellate Court held that a default interest provision in a mortgage note does not violate Illinois law. Inland Bank & Trust v. Knight, No. 1-09-0262, 2010 WL 1033652 (Ill. App. Ct. Mar. 19, 2010). In Knight, the borrower refinanced a mortgage loan on a multifamily apartment complex. The note for the new loan included an “interest after default” clause that permitted the lender to increase the variable rate on the loan upon default. After the borrower defaulted and the lender sued to foreclose, the borrower argued that the clause violated Illinois law, including the Illinois Interest Act, and constituted an unenforceable penalty. The lower court ruled for the lender and the borrower appealed. According to the appellate court, “default interest serves to balance the risk of lending to a defaulted borrower whereas late charges are more akin to a one-time penalty for missing or delaying a scheduled payment.” The court therefore held that the Illinois Interest Act was inapplicable to the default interest clause, which “affected the stated interest rate of the Note itself,” rather than providing for late payment penalties. The court also found that the provision for higher interest following default was not unreasonable given (i) that it was negotiated and agreed upon by both parties, (ii) the losses sustained by the lender due to the default, (iii) the difficulties involved in proving default losses, and (iv) Illinois case law supporting the lender’s position that the clause was valid and enforceable. The court therefore held that the default interest clause did not constitute an unlawful penalty.