We previously wrote an article outlining the legal late fee interpretation. Let me expand on this concept a little more and how it can affect you as the lender. We typically do many of our loans at 12% interest as many of you well know. We need to do this to stay competitive with our competition.
Of course, everyone would like to earn higher rates without being in higher risk loans. One way to do this is through late payment fees. Although you may be earning 12% a year, that is your base rate. Many borrowers may be late on their payments from time to time. This could raise your overall rate of return!
Late Fees Can Be Profitable
Banks, credit card companies, and other lenders thrive on late fees as that is where they make a good chunk of their profits — for example, U.S. credit card companies hauled in $12 billion in late fees in 2016 alone. The late fees also encourage the borrower to pay on time. Borrowers often do not realize the effect they cause when they are late on payment. Thoughts like “are they in trouble” or “is my investment still safe?” crosses everyone’s mind when a payment is delayed. For those feelings of discomfort, late fees are the compensation.
You will always receive them because you do not sign off the mortgage until they are calculated and added to the loan repayment amount. Yes, you could begin a foreclosure, but remember that is costly and mostly it is the lawyer that reaps much of the rewards of a foreclosure process. Foreclosure should always be considered a “last resort” when it is quite clear that the borrower has no prospects of making the payments or paying back the mortgage.
Borrowers sometimes have challenges paying the late fees if they are a week late for example, but can make their monthly payment. The borrower only has the resources available to keep up with the monthly payments, not to catch up on late fees. In a case like that, we would recommend that the lender put those late fees on the tail end of the loan (during repayment of principal) rather than start a foreclosure over them.
Reasons For Late Payment
What are the reasons most people are late on a payment, you might ask? There could be a health reason. We have had borrowers become ill for a short duration only to recover later. But catching up is often very difficult.
One of the other reasons could be that they are in a seasonal business and their low season is coming to an end then take off during high season, that type of scenario. We often hear: “I am out of the country and cannot wire from here.” “I was at the beach with my family.”
By tacking on the late fees to the principal amount at the end of the term, you allow them to continue with their repayment strategy. As long as they are making their monthly payments, the fees can accrue to the end of the term giving you a bigger payout. I would definitely re-read the in-depth article on what the law is and how the debt is calculated again to refresh your memory or perhaps did not get a chance to read it as it was sent out some time ago.
In conclusion, late fees are there to incentivize the borrower to pay on time, which gives you peace of mind. They can also enhance your return if the borrower makes their monthly payments, but not always on time.