Late Fee Defintion, How It Works, Credit Score Impact

What Is a Late Fee?

The term late fee refers to a charge consumers pay when they fail to make a payment on a debt such as a loan or a credit card, or any other type of financial agreement such as an insurance or rental contract by the due date. When a borrower misses a payment, the lender adds the late fee to the outstanding balance, which increases the following month.

Late fees encourage consumers to pay on time and are outlined in the contract or agreement. Borrowers must be notified about any changes to late fees in advance in writing by the lender.

Key Takeaways

  • A late fee is a charge imposed on a consumer who fails to make the payment on a debt or other financial obligation by the due date.
  • All late fees must be explicitly outlined to borrowers and must be reasonable.
  • Late fees generally range between $25 to $50.
  • Late fees can increase account balances and can hurt a consumer's credit history.

How Late Fees Work

Lenders and other creditors make money in a variety of ways including by charging borrowers and debtors fees. Late fees are one of those levies. Late fees are imposed on people who don't fulfill their financial obligations by a certain date. For instance, a credit card borrower who fails to make their payment—at least the minimum—by the due date incurs a late fee that shows up on their next statement. Or a landlord may charge their tenant a late fee for not paying their rent on time.

All late fees must be explicitly outlined to borrowers, regardless of whether they're credit card agreements, leases, or any other type of contract. Creditors legally can't charge excessive late fees, which means they must be reasonable. In most cases, late fees typically range anywhere between $25 and $50.

Some creditors may provide a grace period before the late fee is charged. For instance, rent may be due for an apartment on the first of every month. But the landlord may allow the tenant to pay the rent by the 10th of the month without incurring a late fee. If rent is paid on the 11th or any day after that, the landlord may charge the tenant a late fee in addition to the outstanding rent. As noted, this must be clearly stated in the lease agreement.

Some creditors may waive the late fee the first time a consumer misses the payment deadline while others do not charge any late fees at all. Still, other lenders offer no leniency and charge a late fee even if a borrower barely misses the payment deadline. If charged, these fees can increase the outstanding account balance. For example, the late fee is added to the next month's credit card statement. Not only does this increase the balance by the amount of the late fee, but the borrower is also responsible for any additional interest as a result of that fee, further compounding the amount a borrower owes.

Late fees can impact a person's credit score and overall credit history. That's because payment history plays a big role in credit reports, making up about 35% of a person's FICO score. So the more payments a person misses, the more they will have to pay in late fees and they can also expect to see a big hit on their credit report.

It's important to make your payments on time not only to avoid late payment fees but also because your payment history makes up about 35% of your FICO score.

Special Considerations

Late fees are just one of several fees companies charge consumers in order to make money. For instance, credit card consumers are also subject to annual fees, balance transfer fees, foreign transaction fees, and returned payment fees. All of these fees are avoidable if the cardholder carefully selects the credit card, follows the terms, and avoids behaviors that trigger such fees.

It's always a good idea to pay a credit card on time and in full each month. But if a borrower can't pay off the full balance, making at least the minimum monthly payment on time means they can avoid being charged a late fee and other charges. In some cases, late fees also come with other charges. For example, if a borrower's checking account does not have enough money to cover a credit card payment, not only will the payment still be considered late, the cardholder will also incur a returned payment fee from the credit card issuer as well as a non-sufficient funds (NSF) fee from the bank.

Lenders may also review and alter interest rates based on payment history. This is referred to as penalty repricing, which means the interest rate will increase to the penalty annual percentage rate (APR) because the lender considers the borrower to be a high credit risk. Making a late payment may be a simple oversight, or it could be a sign of financial trouble.

Article Sources
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  1. MyFICO. "What's in my FICO® Scores?" Accessed Oct. 09, 2020.