What is Arrears
Arrears refers to either payments that are overdue or payments that are to be made at the end of a period. An account is said to be in arrears if the debt, liability, or obligation expected is overdue. If one or more payments have been missed in transactions where regular payments are contractually required, such as mortgage or rent payments and utility or telephone bills, the account is in arrears.
An account is also said to be in arrears after a service has been provided and completed, in which case, payment is expected to be made after the completion, not before.
BREAKING DOWN Arrears
In the contractual context, payment is usually made before or after a product or service is provided, according to the terms of the agreement between the two parties. Payment made before a service is provided is common with rent, lease, prepaid phone bills, insurance premium payments, internet service bills, etc. 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 becomes in arrears and the account holder may get a late notice.
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 and occur at the end of the period, therefore, are not classified as late payments.
Arrears can also be applied in the banking and credit industry for annuity payments. An annuity such as a loan repayment is a series of equal amounts of payment that occurs at equal time intervals e.g. $250 per month. 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.
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.
In the investment world, arrearage 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, if the company misses a cumulative dividend payment, the dividends are said to be in arrears. The dividends in arrears must be disclosed in the footnotes to the financial statement. The company will also be restricted from making any dividend payouts to common shareholders until it settles its dividends payable account.
Interest payments on bonds are usually paid in arrears. When an issuer makes $50 coupon payments semi-annually, this means that the interest on the bond would have to accrue for six months before any payment is made to the bondholders.
In summary, the term ‘in arrears’ may or may not have a negative connotation depending on what context it is used in.