How to Charge Interest on Late Payments

While it won't make you popular with customers, charging interest can help tackle late payments. Find out how to get your customers to pay

How to Charge Interest on Late Payments

Late payments are something to be avoided – they can halt your cashflow and, ultimately, stymie your business practices.

Charging interest on late payments can be a good way of counterbalancing any cashflow difficulties and persuading debtors to pay up.

Your right to collect interest on late payments is protected by law, and customers who refuse to pay interest can face legal action – though legal recourse should always be a last resort.

This guide will help you:

Establish whether and when to charge interest.

Calculate the amount of interest owed.

Persuade customers to pay.

Should I charge interest?

Remember that the interest you collect may not be worth the drawbacks that doing so will incur, especially if the debt amounts to an insignificant sum. Ask yourself the following three questions to gauge if charging interest will be worthwhile:

How your customers will react? Consider whether charges will be levied at only a few customers or all of them, and how customers are likely to react to harsh or lenient rates.

What state is your credit control system in? Your system should suit your business needs – unless you can effectively collect the debts that you are owed, your customers can protest against penalties that stem from, in their eyes, your own failings.

What do your competitors charge? Consult your own customers and your trade association.

When should I start charging interest?

This is largely up to you. However, it’s sensible to agree any payment schedule with your customer beforehand, and then make sure they are reminded clearly and in good time when money is due.

There are a few standard timeframes most businesses use. Often, interest will kick in after the last day of an agreed credit period. You should mutually agree this period in writing – it makes the agreement harder to disprove in periods of dispute.

Another common option is after a standard 30 day default period. This is the standard legal practice for when interest can be charged if no credit period has been agreed upon. The 30 day default period begins either when you deliver the purchased good or service, or when you notify the customer about the debt – whichever comes later. To inform the customer, send them an invoice or contact them by phone.

Additionally, if your customer pays you regularly on a certain date after they have been invoiced, the credit period can be considered over if they ever fail to submit payment by this date.

The agreement you draw up may, if it is sufficiently detailed, include stipulations about what money is due at what stage (e.g. part payments to be made upon completion of certain stages of a building project, for example).  If these are not met, interest will be charged from the date in question forward.

What rate of interest can I charge?

You can charge the BofE base rate plus 8%.

The base rate is recalculated twice a year and fixed for six month periods.

Click here to find out the current rate.

How should I calculate interest?

Calculating the amount of interest due is very simple.

Multiply the amount owed by the total rate of interest (base rate plus 8%).

E.g. if the customer owes £1,000 and the base rate is 0.5%, a full year’s worth of interest will be £85.

Divide by 365 to reach the daily rate.

E.g. £85/365 = 23p

Multiply the daily rate by the number of late days to reach the amount due.

E.g. if it is 14 days late the interest charge will be £3.26.

Keep in mind that:

Your VAT position is unaffected.

Part payments go toward reducing interest before reducing the original debt.

A payment of £1,000 on a debt of 1003.26 would leave £3.26 outstanding, on which interest will continue to accrue.

How do I claim interest?

Your strategy for collecting interest should be incorporated into your credit control scheme and can be broken down into the following steps.

1. Inform the customer. Outline in writing that you intend to charge interest, as is your right by law. Regular late payers should be informed about how their late payments disadvantage both you and them.

2. Ensure a mutual understanding/agreement of your payment terms. Include the payment date on your invoices, as well as any new terms and conditions.

3. Notify customers once interest begins accumulating, Inform them of the original invoice number, the relevant account, the amount owed, the daily interest charge, and instructions for payment.

4. Present the final bill once all payment has been paid. This should include the amount of days that interest was charged on and how the interest was calculated.

What do I do if a customer refuses to pay?

A customer is obliged by law to pay any interest you charge that falls within the legal requirements. However, taking legal action for non-payment can be costly and irrecoverably damage your relationship with the consumer. Take whatever steps you can to avoid this option.

Firstly, try to pursue an agreement. Let the customer know this would be preferable to legal recourse.

If you’re still not having any luck,  consider placing the customer on a stop list. This can put pressure on them to pay the debt they owe.

You can also sell the debt on to a third party (e.g. a debt collection agency) if you don’t want to, or don’t have the resources, to chase the debt yourself. This third party has the right to pursue the debt and interest to the courts.

If, however, legal action is unavoidable, then make sure you submit as much written evidence supporting your claim as possible. If you have legal expenses insurance, the threat of legal action can be the final element needed to persuade the customer to pay up.

Where can I get help?

Your first point of call, if you have one, should probably be your accountant.

You can also ask for advice from your local business support organisation or trade association. Your business association can go to court on your behalf, provided you are a small business with fewer than 250 employees.

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