Late Fees and Interest Assessed on Overdue Invoices
An invoice is a document used to bill clients. Once received, an invoice obliges a person or business to pay for goods or services rendered. But what happens if someone refuses to pay an invoice? After providing a business or individual with a written notification, the organization who issued the invoice may charge late fees or interest due on the late payment. Notably, however, local rules and laws impact late fees and interest assessed on overdue invoices.
What are Late Fees?
Companies have the liberty to levy an additional charge or fee when an invoice is left unpaid for an extended period of time. On top of that fee, companies can charge an additional interest rate on the unpaid amount.
Why Charge Late Fees?
Late fees are incentives for clients to pay for the services they are received and to pay in a reasonable amount of time. Otherwise, companies providing those services will experience interruptions and possibly complications in their cash flow. Ultimately, this can lead to financial complications, especially for small businesses.
What Creates a Late Fee?
Late fees and interest assessed on overdue invoices depend on the length of time a company has given a client or subscriber to pay for an invoice. The standard due date for an invoice is 30 days after receipt of the invoice but may be any date determined by a company.
If there is an unpaid invoice after the allotted time, companies can charge late fee amounts for business and individuals. Typically, a company’s contractual payment term clause will contain a clause about the payment structure and any penalties for late payments. This may include a daily penalty interest rate or some other standard late fees.
Standard late fees are not regulated by states or the federal government. However, there are state caps on interests. Interest rates are usually quoted as an annual percentage, but can be calculated annually, monthly, daily, or really any period of time.
Local Laws Affect Interest Charged on Overdue Invoices
Some states have one percentage for contracts with preexisting written agreements containing explicit interest rates and another percentage for agreements that are silent on late fees. For example, Alabama has a legal maximum interest rate of 8% per a year for written agreement and a maximum rate of 6% per a year for agreements not containing a specific clause.
Here are some examples of states legal rates:
- California restricts contract rate at 12%.
- Massachusetts at 6%, unless there is a contract.
- Colorado at 8% if there is no agreement and a maximum of 45%, one of the highest interest limits in the country.
- Nevada has no limit for contracted interest rates, otherwise, there is a prime rate at largest bank in Nevada plus 2%.
It is left up to a company’s discretion whether they charge clients a flat fee or percentage of the unpaid overdue amount. Late fees and interest on late fees is only enforceable if the original contract, or agreement, created between parties contains an explicit and clear late fees or interest clause.
An example of a clear clause may be “Accounts not paid within terms are subject to a [blank]% monthly finance charge.” This should be displayed in a readable, bold font on the contract near the signature line to avoid any conflicts.
Determining a Late Fee
A company may determine the late fee and attach a demand letter to the next invoice with the new amount due. To determine a late fee, there is an online calculator which requires entering the number of days (or months) late the payment is, the amount of the original invoice is, and the interest rate your contract specifies.
For calculating late fees with the addition of the interest rate, divide the annual rate by 12 to account for the 12 months of the year. If a state allows for 12% a year, that equates to 1% per a month. If you have an invoice that is $1,000, the interest for that month is $10.
When to Apply a Late Fee
It is best practice to send a late payment reminder to a client before charging the late fee or the interest rate charges. This provides a grace period for clients, especially when it is unknown why the client is late with a payment or uncharacteristic of the client to be late with a payment.
It is important to weigh the pros and cons of implementing a late fee to a client. There are often circumstantial reasons why clients are late with payments. A businesses’ first obligation should be to conduct fair and true business and hold amicable business relationships, in which case, applying a late fee as soon as a payment is late or missed will only cause turbulence and could cost a client.
When are Late Fees Charged?
A late fee can be charged any time after a payment is due (i.e. after the 30-day invoice period). However, a company who values their customer relationships will offer a grace period between when the payment is due and when they charge the assessed late fee.
Interest on Overdue Invoices
Charging interest on unpaid invoices is standard practice in most industries. Companies are legally entitled to charge interest rate. But this type of interest is only enforceable if there is an existing agreement about late fees between the company and the client on the payment terms and the conditions of interest on unpaid invoices. If there is no existing agreement, the client is not obligated to pay any interest on unpaid invoices.
Although interest rates are not directly regulated, some states do restrict the amount that a company can charge in late fees and cap the interest rate percentage. Typically, companies should charge no more than 10% per year on late fees and invoices. However, organizations should check with the appropriate state regulations to confirm what percentage rate is allowed in their jurisdiction.
How to Avoid Late Fees and Interest Rates
It can be a waste of time and resources to track clients down for invoices, and especially for unpaid invoices. To avoid having to assess late fees and interest rates on invoices, companies should provide a financial incentive for paying invoices on time. Organizations may want to consider offering a discount for full payment upfront or within the invoice payment period. This is a successful tactic to avoid having to deal with late fees or interest rate charges against clients and risking a business relationship.
To make sure they don’t unintentionally leave invoices unpaid, businesses should invest in good accounting systems. Consider creating reminders and electronic notices to help keep organized and make payments on time. Setting up electronic payments or transfers can also make it easy to draft directly from your business account to the company or service provider.
Of course, none of this information should be taken as legal or financial advice, nor should it deter you from seeking the assistance of a licensed attorney, accountant, or financial services professional. But if you want to make sure your company’s policies regarding late fees or interest assessed on overdue invoices are consistent with best practices, this is a great place to start!