Some Thoughts On Late Charges And Default Rate Interest

• Published date: 01 September 2020
• Subject Matter: Finance and Banking, Charges, Mortgages, Indemnities, Financial Services
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Steven Herman

In mortgage loan transactions, lenders will customarily charge a fee for late payments and additional (or default) interest upon a default. The late fee is often a percentage (e.g., five percent) of the unpaid installment and is meant to compensate the lender for its administrative costs in handling and processing the delinquent payment and for the loss of the use of such delinquent payment. Default rate interest, on the other hand, is an increase in the interest rate by a specified percentage in the event of a default and is meant to compensate the lender for its increased risk in dealing with a borrower that has defaulted. Default interest is also meant to compensate the lender for any lost opportunity cost in reinvesting the loan proceeds and for its costs in administering a defaulted loan.¹ Finally, default interest serves as a deterrent to a borrower from defaulting a loan.

One issue that arises with respect to late charges is whether a late charge may be applied on the payment at maturity. Borrowers routinely object to charging a late charge on the balloon payment. In Trustco Bank New York v. 37 Clark Street, Inc., the mortgage note provided that a late charge of six cents for each dollar overdue could be assessed 'for the purpose of defraying the expense incident to handling delinquent payment.' The borrower failed to make a payment of the entire amount due under the note at maturity, and following that default, the lender accelerated payment. The lender sought to recover the late charge for the failure to make the balloon payment, and the borrower objected, arguing that the late charges were an 'oppressive forfeiture' and impermissible penalty. The...