In the Penalty Box: Default Interest
It used to be axiomatic. The borrower and its lender would enter into a loan agreement or a finance lease, and agree that, upon an event of default or even a delinquent payment, interest would be charged on that payment (or upon the entire contract balance, if the event of default was followed by an acceleration of the contract balance) at a noticeably higher rate. The purpose of the enhanced interest rate was to motivate the obligor to pay on time and avoid any serious breach of its other obligations.
There were other reasons: An obligation that is in default requires additional attention by the lessor or lender, including internal workout staff and possibly in-house counsel. This involves extra expense, not always quantifiable like outside counsel fees. An enhanced interest rate is designed to compensate the lessor or lender for these unexpected costs.
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“In the Penalty Box: Default Interest,” by Stephen T. Whelan was published in the October 2018 edition of Equipment Leasing & Finance Magazine. Reprinted with permission.