Late payment interest: Overview, definition and example
What is late payment interest?
Late payment interest is a financial charge applied when a payment isn’t made on time under the terms of a contract. It’s a way to compensate the party owed money for the delay and incentivize timely payments. The interest is typically calculated as a percentage of the overdue amount and can be charged daily, monthly, or annually until the payment is made.
For example, if a client fails to pay an invoice by the due date, the service provider may add interest to the outstanding balance until it’s settled.
Why is late payment interest important?
Late payment interest is important because it encourages parties to honor payment deadlines. For the party owed money, it helps offset the financial impact of late payments, such as cash flow disruptions or additional administrative costs. For the paying party, it acts as a clear consequence of failing to meet their obligations, promoting accountability.
Including a late payment interest clause in contracts ensures that everyone understands the cost of delayed payments upfront, reducing disputes and improving payment discipline.
Understanding late payment interest through an example
Imagine a marketing agency sends an invoice for $10,000 to a client with a "Net 30" payment term and a 2% monthly late payment interest clause. If the client doesn’t pay by the due date, the agency adds $200 (2% of $10,000) for each month the payment is overdue. If the client pays two months late, they owe $10,400 in total.
In another scenario, a supplier delivering goods under a contract includes a late payment interest clause stating 1.5% interest per month on overdue payments. If a $5,000 invoice is unpaid for three months, the interest adds up to $225, making the total due $5,225.
An example of a late payment interest clause
Here’s how a late payment interest clause might look in a contract:
“In the event that any payment due under this Agreement is not received within the agreed payment terms, the paying party shall incur interest on the overdue amount at a rate of 1.5% per month, calculated daily from the due date until full payment is received.”
Conclusion
Late payment interest clauses provide a fair and practical way to address overdue payments. They compensate the party owed money for delays and incentivize timely payments, helping to maintain cash flow and trust in business relationships.
By including clear late payment interest terms in contracts, businesses can protect themselves from financial risks, encourage prompt payments, and reduce misunderstandings about the consequences of delays. It’s a straightforward tool for promoting accountability in financial transactions.
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.