In mortgage loan transactions, lenders usually charge a fee for late payments and additional interest (or default) in the event of default. Late fees are often a percentage (for example, five percent) of the unpaid payment and is intended to compensate the lender for its administrative costs of processing and processing the overdue payment and for the loss of use of that overdue payment. The default interest rate, on the other hand, is an increase in the interest rate by a specified percentage in the event of default and is intended to compensate the lender for their increased risk of dealing with a defaulting borrower. Interest on arrears is also intended to compensate the lender for any opportunity costs lost in reinvesting loan proceeds and for its costs of administering a delinquent loan.[1] Finally, late payment interest is used to dissuade a borrower from defaulting on a loan.

One question that arises in relation to late fees is whether late fees can be applied to payment when due. Borrowers routinely object to the imposition of late payment fees on lump sum payments. In Trustco Bank New York v. 37 Clark Street, Inc., the mortgage note provided that a late penalty of six cents for every dollar overdue could be imposed “to cover expenses associated with processing overdue payments.” The borrower failed to make payment in full of the amount owed under the note at maturity and, as a result of this default, the lender accelerated payment. The lender sought to recover the late charge for the failure to make the lump sum payment, and the borrower objected, arguing that the late charge constituted “unreasonable forfeiture” and an ineligible penalty. The Court held that the late charge provision should be interpreted as applying only to monthly defaults giving rise to a collection charge, and not to defaults on payment when due, such as a lump sum payment resulting in a acceleration. Such defaults, the Court noted, terminate the borrower’s right to correct the default. Therefore, the late charge did not apply to the lump sum payment.[2]

To determine the enforceability of late fees and late interest, the courts examined whether the amounts charged had a punitive intent. If the charges are so high that they suggest a punitive intent rather than an intent to compensate the lender for their charges, the courts have struck them down. In Emigrant Funding Corporation v. 7021 LLC, the contractual interest rate was 7.25% and the default interest rate was 24%. The Court held that the parties are free to agree that a contractual interest rate will increase in the event of default, as long as the interest rate is not usurious or constitutes a penalty. In this case, the lender charged the borrower both the contractual interest rate and the default interest rate during the periods when the borrower did not make his installment payments. The Court ruled that the imposition of default interest in the amount of 24% on top of the contractual interest rate of 7.25%, resulting in a total interest charge of 31.25%, was criminal usurious. While each case is specific to the facts, criminal usury in New York seldom applies to larger loans with sophisticated parties given existing legal exemptions. However, the court rejected the borrower’s argument that a default interest rate of 24% was a penalty and nullity contrary to public policy. The Court held that the default interest provision was valid and enforceable, noting that “it is well established that an agreement to pay interest at a higher rate in the event of default or maturity is an agreement to pay interest and not a penalty ”.[3]

Another consideration for the default interest rate is when it should be triggered – upon the occurrence of an event of default or when the lender accelerates the loan. Lenders would prefer the first, while borrowers would prefer the second. In In re Crystal Properties, Ltd., LP, the promissory note stipulated: “In the event of default of payment provided for in this note, … at the option of the holder hereof and without notice or request, the entire balance of principal and accrued interest remaining unpaid will become immediately due and payable. and, thereafter, bear interest, until full payment, at the rate plus five percent (5%) per annum in addition to the rate contracted herein. No delay or omission on the part of the holder of these presents in the exercise of any right hereunder,… shall operate as a waiver of this right or of any other right hereunder… ”The lender has made argue that because the note expressly stated that default interest is due and payable in the event of default “without notice or demand”, the default interest rate should have accrued at the time of default. However, the Court disagreed, noting that the wording “at the option of the holder” provides that the right to accelerate the unpaid debt is at the option of the lender. In addition, if the option is exercised, the note will bear interest “thereafter” at the default rate, which can only mean that the default interest rate does not take effect unless the holder of the note exercises his option. acceleration. Therefore, the Court concluded that the wording of the note required the holder to exercise their acceleration option before the default interest rate was triggered.[4]

In financing transactions, many borrowers will further negotiate the default interest provisions to clarify whether default interest accrues from the occurrence of the default or the occurrence of an event of default. Often times, an event of default may not occur until a significant grace period has passed (such as thirty, sixty, or ninety days), and many lenders are reluctant to allow the accumulation of credit. interest on default rate for such an extended period of time. Lenders will say that if the default never turns into an event of default, the default would have been corrected and the relevant question would become moot.

Late fees and late interest are monetary matters that must be carefully drafted to ensure that the parties have contracted for what will ultimately be enforceable and what was intended by the parties.

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