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How a Grace Period Works

A grace period is a specified period of time after a due date for a loan payment. The grace period allows the borrower to delay payment beyond the due date without incurring a penalty. 

This means there can be no extra charges or cancellations of the loan as long as the payment due is paid before the grace period ends. The borrower’s credit report is also unaffected by late payments as long as they are eventually paid within the grace period.

The length of a grace period will be determined in the loan contract. For example, the grace period for a mortgage is typically 15 days. Long-term loans like mortgages usually have grace periods written into the contracts as standard practice.

Grace periods in contracts

Grace periods can be inserted into any contract involving recurring payments, although they are not standard practice across the board. If you are entering into such an arrangement, it is vital to check the details of the contract to see if there is a grace period and how long it lasts. 

You should also ensure you fully understand the consequences of failing to make a payment within the agreed grace period. Failure can incur penalties, usually in the form of a late payment fee, a penalty interest rate hike as described below, or even the complete cancellation of the loan agreement. 

If an asset has been offered as collateral on the loan, then a late payment can result in the seizure of the asset by the lender, depending on the wording of the agreement. Collateral is usually used for large loans, and in such circumstances, it will usually require multiple missed payments to instigate seizure of the asset. However, there are instances where just a single missed payment can result in the lender using their lien to recoup the debt.

Compound interest during grace periods

Many loan contracts add compound interest on late payments even if they are paid before the end of the grace period. Some do not charge additional interest, but you should always be aware of the specific grace period details of any loan agreement you make.

Typically, it is worth noting that credit card repayments do not have grace periods for monthly minimum payments. Late payment in this instance usually results in a penalty charge, with compound interest added for every day the payment isn’t made.

Insurance policy grace periods

An insurance policy grace period represents the time between the date a payment is due and the moment the insurance coverage is revoked due to non-payment. Different insurance policies have different grace periods, but they usually range somewhere between one day to one month after the due date.

A missed payment that results in insurance coverage being revoked doesn’t necessarily mean the end of that policy for good. The coverage can be reinstated with new payments, but the insurance company may want to inspect the item being reinsured to check for any damage that may have occurred during the grace period. They will also probably add financial penalties for late payment.

Differences between grace periods and deferment

A deferment is also a period of time that allows a borrower not to make a payment by the due date. However, a deferment differs significantly from a grace period as it is a singular event that the borrower must apply for. 

A borrower who cannot make a payment and needs to defer will request a deferment from the lender. Typically, this occurs when the borrower undergoes unexpected financial hardship. The lender will require documentation to verify the circumstances and prove the financial hardship. Lenders that approve a deferment usually continue to add interest during the period of deferment.

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If you’re interested in finding out more about how a grace period works, or any other aspect of your business and its finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.

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