Additional interest: Overview, definition, and example
What is additional interest?
Additional interest refers to extra interest charges that are added to a loan or financial obligation under specific circumstances. It typically occurs when certain conditions or covenants of the loan agreement are not met, or if certain events trigger an increase in the interest rate, such as a late payment, breach of contract, or a change in the financial status of the borrower. Additional interest can be imposed to compensate the lender for the increased risk, delays, or non-compliance with the terms of the loan.
For example, a loan agreement might specify that if a borrower fails to make a payment on time, an additional interest charge will apply to the outstanding balance.
Why is additional interest important?
Additional interest is important because it protects lenders from potential risks and losses due to delays or defaults by borrowers. It serves as a financial incentive for borrowers to meet their obligations on time and according to the terms of the agreement. For borrowers, understanding the potential for additional interest charges is critical to avoid unexpected costs or penalties.
For businesses, additional interest provides a way for lenders to manage risk and ensure that they are compensated if a borrower fails to meet contractual obligations. For borrowers, being aware of the terms regarding additional interest helps them avoid penalties and keep costs under control.
Understanding additional interest through an example
Imagine a business takes out a loan of $100,000 with an interest rate of 5% per year. The loan agreement stipulates that if the business fails to make a payment on time, an additional interest charge of 2% will be added to the outstanding balance.
If the business misses a payment and the additional interest is applied, the new interest rate would be 7% for the period of time the payment remains overdue. This results in higher interest payments, increasing the overall cost of the loan.
In another example, a company issues bonds to raise capital and offers a fixed interest rate to investors. However, the bond agreement includes a clause stating that if the company’s credit rating drops below a certain level, additional interest will be applied to the bonds to compensate investors for the increased risk. This additional interest helps protect investors from the potential risks associated with a downgrade in the company’s financial standing.
An example of an additional interest clause
Here’s how an additional interest clause might appear in a loan or bond agreement:
“In the event that the Borrower fails to make any scheduled payment within 30 days of the due date, an additional interest rate of 2% per annum will be applied to the outstanding balance, effective from the date of default until the payment is made in full.”
Conclusion
Additional interest is a common financial provision that increases the cost of borrowing when certain conditions are not met or when risks increase. It provides a safeguard for lenders and encourages borrowers to meet their obligations on time.For businesses, understanding the potential for additional interest charges is essential to managing cash flow and avoiding unnecessary expenses. For lenders, it ensures compensation for risk and protects the value of the loan agreement.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.