Interest after default: Overview, definition, and example
What is interest after default?
Interest after default is the additional interest a borrower must pay if they fail to make a required payment on time. This higher interest rate, often called a default rate, is applied to the outstanding debt as a penalty for late payment or breach of contract.
For example, if a business takes out a loan and misses a payment deadline, the lender may charge a higher interest rate on the overdue amount until the borrower catches up on payments.
Why is interest after default important?
Interest after default is important because it protects lenders from financial losses when a borrower fails to meet their payment obligations. It also encourages borrowers to make timely payments by increasing the cost of non-payment.
For businesses, understanding default interest is crucial when signing contracts, as failing to pay on time can quickly increase debt costs. If a business takes out a loan or agrees to credit terms, knowing the potential penalties for late payments helps in financial planning.
Understanding interest after default through an example
Imagine a small business secures a $50,000 loan with a 6% annual interest rate. The loan agreement states that if the business misses a payment, a default interest rate of 12% will apply to the overdue balance.
- The business misses a scheduled $5,000 payment.
- The lender applies the 12% default interest rate to the unpaid amount.
- Until the business pays the overdue $5,000, interest accrues at twice the normal rate.
In another scenario, a supplier extends credit to a retailer with 30-day payment terms. If the retailer doesn’t pay on time, the supplier charges default interest of 1.5% per month on the overdue amount until it is paid. This helps the supplier manage cash flow and discourages late payments.
An example of an interest after default clause
Here’s how an interest after default clause might appear in a contract:
“If the Borrower fails to make any payment when due, the outstanding amount shall accrue interest at the Default Rate of [X%] per annum from the date of default until paid in full.”
Conclusion
Interest after default is a financial penalty applied when a borrower fails to make a payment on time. It compensates lenders for the risk of late payments and encourages borrowers to meet their obligations.
For businesses, understanding default interest clauses in contracts is essential to avoid unexpected costs and manage financial obligations effectively.
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.