Calculation of interest: Overview, definition and example
What is calculation of interest?
Calculation of interest refers to how interest is computed on amounts owed under a contract—such as late payments, outstanding debts, or delayed reimbursements. It outlines the interest rate, frequency (e.g., daily, monthly, annually), and method (e.g., simple or compound) used to determine how much extra is payable over time.
Why is calculation of interest important?
Clearly defining how interest is calculated helps avoid disputes over payment amounts. Without this clarity, one party might overcharge or underpay based on differing assumptions. For lenders, suppliers, or service providers, having a consistent and enforceable formula ensures they’re compensated for delays or risk. For borrowers or customers, it offers transparency and predictability.
Understanding calculation of interest through an example
Suppose a vendor agreement states that overdue payments will accrue interest at 1.5% per month. If a business misses a $10,000 payment and doesn’t pay for two months, they’ll owe $10,300 in total—$300 in interest. If the clause didn’t specify the interest rate or calculation method, the parties might argue over how much is owed, leading to delays or legal costs.
Example of a calculation of interest clause
Here’s how a calculation of interest clause may appear in a contract:
"Any amount not paid when due shall accrue interest at a rate of 1.5% per month (18% annually), calculated on a daily basis and compounded monthly, from the due date until the date of actual payment."
Conclusion
Calculation of interest clauses define how much extra is owed when payments are late. These clauses benefit both parties by setting expectations upfront and helping to resolve payment issues quickly. When drafting or reviewing contracts, businesses should check that the rate, method, and timing of interest calculations are clearly defined.
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.