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How to Charge Interest and Late Fees on Unpaid Invoices

Updated Dec 21, 2023

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You held up your end of the deal by rendering services or delivering goods. However, your client is ignoring the invoice. It’s an unpleasant situation with implications for your cash flow, accounts payable process and customer service. You’ve sent second notices, statements or demand letters, but nothing is working. How can you collect past-due invoices effectively and prevent late payments in the future? 

The answer is making late payments painful for the client by charging late fees or interest on unpaid balances. These charges help alleviate cash flow problems and reimburse you for collection efforts. It also incentivizes clients to pay on time to avoid paying more for their procrastination.

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What are interest fees?

An interest fee is additional money the client owes you over and above the original invoice amount if they pay late. The interest rate is a percentage of the unpaid balance that accumulates every month the invoice remains unpaid. The interest rate usually is displayed as an annual rate, for example, 10 percent. But since it accrues monthly, the amount charged is that annual rate divided by 12. So, a 10 percent annual interest rate would be 0.83 percent each month. 

Interest fees usually compound to serve as a more substantial disincentive for late payments. This means that if the interest is charged in month two, it’s added to the balance due. If the customer still hasn’t paid by month three, the monthly rate is applied to the new balance. 

For example, let’s say you invoice a client $200 with net 30 terms. The first month comes and goes with no payment. Now, you would apply the 0.83 percent to the $200 balance:

$200 x 0.0083 = $1.66 This is the interest fee for month one. 

At the end of month two, the customer now owes:

$200 original balance + $1.66 interest = $201.66

If the customer does not pay in month three, the interest is applied to the new balance:

$201.66 x 0.0083 = $1.67 interest

At the end of month three, the customer now owes: 

$201.66 + $1.67 = $203.33 

Since the interest fee is based on the amount owed, the penalty amount keeps increasing the longer it remains unpaid. While it doesn’t look like much, interest fees can accumulate quickly, especially if the original invoice amount is significant. Customers will feel pressure to pay as they see the amount owed ballooning. 

TipBottom line

Ensure all company information on your invoices is accurate so customers can contact you to pay with a credit card by phone, email you with questions or mail a check to your business address.

What are late fees?

Late fees are another financial penalty for late payment. Instead of multiplying the balance by an interest rate, you would charge a flat amount when a payment is late. Most late fees are between $25 and $50. For example, you may charge a late fee of $25 when an invoice is not paid according to the terms. Some companies use a percentage of the invoice amount to calculate the late fee, but this amount does not compound as it would be the same amount each time.

If the customer continues not to pay, you can assess multiple late fees as long as these terms were laid out in your written agreement before the sale and on your invoices. They must also comply with state law. You can also set the frequency at which late fees will be assessed, such as daily, weekly, monthly or quarterly. State laws often cap the total amount of allowable late fees, which are usually tied to the invoice amount. 

Since late fees are generally larger amounts that accumulate more quickly, they can be a stronger incentive for prompt payment than interest fees. For example, on the same $200 invoice as outlined above, a monthly late fee would work as follows after the first month of nonpayment:

$200 original invoice amount + $25 late fee = $225 new balance at the end of month two

If the customer does not pay in month three, another late fee is assessed:

$225 balance + $25 = $250 new balance at the end of month three

However, if your state law caps interest and late fees to no more than 10 percent of the original invoice, it is better to go with interest fees. This is because $50 in late fees is more than 10 percent of $200 and charging this would be illegal.

FYIDid you know

The best accounting and invoicing software can help you effortlessly calculate and track interest and late fees on unpaid invoices.

How do you charge interest and late fees on unpaid invoices?

You can charge interest on unpaid invoices if you stay within the bounds of the law. Late fees are standard practice in many industries. Nevertheless, you should let your client know your intention in advance. The key to charging interest is to do it legally and without losing sight of your goals. Collecting the original invoice amount and maintaining a good relationship with the customer should always be your primary objectives.

When charging a late fee or interest, ensure the original contract the client signed states any fees or interest charges that will be assessed, when they will be assessed, whether they compound and if there is a grace period. A grace period is a time after the invoice is due in which you don’t charge interest or fees as long as payment is made in that window. For example, if an invoice is due on the first of the month, the grace period may be an additional 10 days. That way, you avoid alienating your client if payment is just a few days late.

There are three essential things to know about charging interest and assessing late fees:

  1. You must have a written agreement to assess late fees: Assess late fees only if a written agreement outlines this option. Be sure to include this phrase: “Accounts not paid within terms are subject to a ___ percent monthly finance charge.”
  2. Don’t charge more than 10 percent interest per year: Some states restrict the amount you can charge in late fees, but you’re likely safe if you cap rates at 10 percent.
  3. Don’t call interest or late fees a penalty: Do not describe the interest or late fee as a “penalty.” This could imply that you are attempting to punish the client instead of covering the additional costs involved in collecting the money you are owed. If you have to go to court, this could hurt you.
TipBottom line

Include your interest or late fee policy on all invoices you create, as well as any statements and payment reminders.

When to charge interest or late fees (and when you shouldn’t)

Do charge interest or late fees when:

  • You are in a cash crunch: If your business needs cash now, charging interest or late fees is a necessity for your accounts receivable process.
  • You have clients who consistently pay late: If clients are lackadaisical about paying, they may not view you as a professional business. Instituting an interest rate or late fee policy will hold them accountable. 
  • You have clients who deliberately pay late: Some clients take advantage of business owners and try to get away with stringing your payment for as long as possible. A late fee or interest policy will make them behave — or weed them out.

Don’t charge interest or late fees when: 

  • The payment was late because the customer was dissatisfied: If clients feel the work or product must be revised, they may hold money back until the issue is corrected. Now is not the time to play hardball but to resolve the customer service issue. That may require you to offer a discount, not tack on fees.
  • The client was unaware of the policy: This is where communication upfront is vital. Outline your policy in writing before the sale and include reminders on each invoice. This helps ensure the client isn’t given an unpleasant surprise. If they claim they didn’t know, consider giving them a pass — but let them know that the late fee or interest will be assessed going forward.
  • The payment is late because of a disaster or personal tragedy: It is in poor taste to assess late payment penalties when a client’s business has been impacted by a natural disaster, such as a hurricane or flood, or if they’re grieving the loss of a close family member. This is the time to offer condolences and empathy.
Did You Know?Did you know

If a client refuses to pay and you’ve exhausted your efforts, consider using one of the best collection agency services. Choose a reputable, experienced firm with advanced services like an online portal.

Maximum invoice late fees by state

Some states have laws setting a maximum amount for late fees that businesses can charge; others require you to give debtors a grace period before charging late fees. Here’s a state-by-state breakdown: 

State

Late fee limitations

Alabama

No maximum late fee; seven-day grace period

Alaska

No maximum late fee; seven-day grace period

Arizona

No maximum late fee; five-day grace period

Arkansas

No maximum late fee; no grace period required

California

No maximum late fee; no grace period required

Colorado

No maximum late fee; no grace period required

Connecticut

No maximum late fee; nine-day grace period

Delaware

5 percent per month maximum; five-day grace period

Florida

5 percent of past due amount maximum; 15-day grace period

Georgia

No maximum late fee; no grace period required

Hawaii

8 percent per month maximum; no grace period

Idaho

5 percent of past due amount maximum; 10-day grace period

Illinois

Maximum of $20 or 20 percent, whichever is greater; no grace period

Indiana

No maximum late fee; no grace period required

Iowa

Maximum of $60 per month for balances under $700 and $100 per month for balances over $700; no grace period required

Kansas

No maximum late fee; no grace period required

Kentucky

No maximum late fee; no grace period required

Louisiana

No maximum late fee; no grace period required

Maine

Maximum of 4 percent per month; 15-day grace period

Maryland

Maximum of 5 percent per month; 15-day grace period

Massachusetts

No maximum late fee; 30-day grace period 

Michigan

No maximum late fee; no grace period required

Minnesota

Maximum of 8 percent per month; no grace period required

Mississippi

No maximum late fee; no grace period required

Missouri

No maximum late fee; no grace period required

Montana

No maximum late fee; no grace period required

Nebraska

No maximum late fee; no grace period required

Nevada

Maximum of 5 percent per month; no grace period required 

New Hampshire

Maximum of 5 percent per month; no grace period required 

New Jersey

No maximum late fee; no grace period required

New Mexico

Maximum of 10 percent per month; no grace period required

New York

Maximum of $50 or 5 percent per month; five-day grace period 

North Carolina

Maximum of $15 or 15 percent per month; no grace period required

North Dakota

No maximum late fee; no grace period required

Ohio

No maximum late fee; no grace period required

Oklahoma

No maximum late fee; no grace period required

Oregon

Maximum of 5 percent per month; no grace period required

Pennsylvania

No maximum late fee; no grace period required

Rhode Island

No maximum late fee; no grace period required

South Carolina

No maximum late fee; no grace period required

South Dakota

No maximum late fee; no grace period required

Tennessee

Maximum of $30 or 10 percent per month; five-day grace period

Texas

No maximum late fee; five-day grace period

Utah

No maximum late fee; no grace period required

Vermont

No maximum late fee; no grace period required

Virginia

No maximum late fee; five-day grace period

Washington

No maximum late fee; no grace period required

Washington, D.C.

5 percent per month maximum; five-day grace period

West Virginia

No maximum late fee; no grace period required

Wisconsin

Maximum of $20 or 20 percent per month; five-day grace period

Wyoming

No maximum late fee; no grace period required

TipBottom line

Send electronic invoices with a link to a secure online payment page. This option’s immediacy and convenience can prompt disorganized clients and procrastinators to make payments.

Alternatives to charging interest and late fees

There are other ways to collect your invoices besides charging interest and late fees. Additional options include:

  • Customer communication: Contact the customer to see what’s holding up the payment. It could be something fixed easily. Reaching out shows empathy while still getting the message across that you expect payment. You can use this opportunity to gently remind the client that nonpayment will incur interest or fees.
  • Payment incentives: Wave a carrot instead of a stick by offering a discount for full payment upfront or within 30 days. Sometimes, incentives to pay early or on time can be more effective than threats of fees and interest charges.
  • Collect payment upfront: Asking customers to pay upfront eliminates any potential nonpayment issues. You can also charge an upfront deposit instead of asking for full payment. It’s up to you to decide if an upfront payment or deposit is appropriate for your business.
  • Offering payment plans: Consider offering a payment plan if the client is having financial difficulties. You’ll show empathy while collecting at least some of what is owed. Payment plans usually include an interest charge, although you don’t have to add one.

Interest and late fee charges are viable collection tactics that speed up the debt collection process and compensate you for the costs of interrupted cash flow and additional collection activity. But be sure to do it correctly, or you could alienate customers and get in trouble with the law.

Jennifer Dublino
Contributing Writer
Jennifer Dublino is a prolific researcher, writer, and editor, specializing in topical, engaging, and informative content. She has written numerous e-books, slideshows, websites, landing pages, sales pages, email campaigns, blog posts, press releases and thought leadership articles. Topics include consumer financial services, home buying and finance, general business topics, health and wellness, neuroscience and neuromarketing, and B2B industrial products.
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