What Is Arrears?
Arrears is a financial and legal term that refers to the status of payments in relation to their due dates. The word is most commonly used to describe an obligation or liability that has not received payment by its due date. Therefore, the term arrears applies to an overdue payment.
If one or more payments have been missed where regular payments are contractually required, such as mortgage or rent payments and utility or telephone bills, the account is in arrears. Payments that are made at the end of a period are also said to be in arrears. In this case, payment is expected to be made after a service is provided or completed—not before.
- Arrears is a financial and legal term that most commonly describes an obligation or liability that has not received payment by its due date.
- Being in arrears may not have a negative connotation, as in cases when payment is expected after a service is provided or completed, not before.
- Annuities are called annuities in arrears (or ordinary annuities) when payments are due at the end of the period.
- Arrearage applies to dividends that are due but have not been paid to preferred shareholders.
Arrears, or arrearage in certain cases, can be used to describe payments in many different parts of the legal and financial industries, including the banking and credit industries, and the investment world. The term can have many different applications depending on the industry and context in which it is used.
As noted above, arrears generally refers to any amount that is overdue after the payment due date for accounts such as loans and mortgages. Simply put, it means your payment is late. Accounts can also be in arrears for things like car payments, utilities, and child support—any time you have a payment due that you miss.
Being in arrears may or may not have a negative connotation depending on how the term is used. In some cases, such as bonds, arrears can refer to payments that are made at the end of a certain period. Similarly, mortgage interest is paid in arrears, meaning each monthly payment covers the principal and interest for the preceding month.
Example of Arrears
For example, if your $500 loan payment is due on Jan. 15 and you miss the payment, you are in arrears for $500 as of the next business day.
If you continue making regular payments each month after that, you are still in arrears for $500 until the time you make up the payment you missed. Similarly, if you paid $300 of that Jan. 15 payment, you are in arrears for $200 as of Jan. 16 until the time you pay it off and bring your account up to date.
Being in arrears may or may not have a negative connotation depending on how the term is used.
Payment in Advance vs. Payment in Arrears
When two parties come to an agreement in a contract, payment is usually made before or after a product or service is provided. Payment made before a service is provided is common with rents, leases, prepaid phone bills, insurance premium payments, and Internet service bills. These types of payments are referred to as payment in advance. When the bill becomes overdue—say 30 days past the due date for payment—the account falls into arrears and the account holder may get a late notice and/or penalty.
There are also instances where bills or liabilities come due after the service has been provided such as utility bills, property taxes, and employee salaries. These payments are known as payment in arrears, occur at the end of the period, and are not classified as late. They do, however, fall into arrears if you don't pay them by the due date.
Arrears can also apply to payroll accounting. When payrolls are in arrears, the previous week’s (or some other period's) payments are processed and paid out to employees as opposed to wages earned during the current period. Current pay would instead occur as payroll and processed each period as it ends.
Types of Arrears in Finance
Annuity in Arrears
Arrears can also be applied to instances in the context of finance. One example is for annuity payments. An annuity such as a loan repayment is a series of equal amounts of payment that occurs at equal time intervals—say for $250 per month for 10 years. If the annuities are due at the end of the period such as mortgage payments, they are called an ordinary annuity or annuity in arrears.
Dividend in Arrears
Arrearage also applies to dividends that are due but have not been paid to preferred shareholders. Because preferred shares have guaranteed dividends regardless of whether the company makes a profit or not, dividends are said to be in arrears if the company misses a cumulative dividend payment. The dividends in arrears must be disclosed in the footnotes to the financial statement. The company is also restricted from making any dividend payouts to common shareholders until it settles its dividends payable account.
Interest in Arrears (Bonds)
Some loans have interest in arrears. This means that the interest is due to be paid on the maturity date of the loan, instead of in bits and pieces during the life of the loan like an annuity payment. Interest payments on bonds are usually paid in arrears. When an issuer makes $50 coupon payments semi-annually, this means the interest on the bond would have to accrue for six months before any payment is made to the bondholders.
An arrears swap is an interest rate swap that is similar to a regular, or plain vanilla swap, but the floating payment is based on the interest rate at the end of the reset period, instead of the beginning, and is then applied retroactively.
What Kinds of Payments Can Be in Arrears?
Any overdue payment can be in arrears. Some of the most common types of payments to be in arrears include payroll, mortgage, rent, car payment, child support, credit card, and taxes.
Does Arrears Mean Late?
Arrears refers to a debt or payment that is still outstanding after the payment due date has passed. It is synonymous with the payment being late.
Is Being in Arrears Always Negative?
Not in certain contexts, such as in bond trading, when arrears is a reference to payments that are made at the end of a specified period. Mortgage interest payments are paid in arrears and only suggest a negative connotation when the due date has passed.
Why Do Companies Often Pay in Arrears?
Paying in arrears is often beneficial to businesses as it provides them with the time to have more flexibility with their cash flows—instead of having to pay obligations with current cash flows, they can accrue that cash for later payment. This also allows this accumulating cash to earn interest for the company before it is paid out.