The Misunderstood Late Charge – A Basic Guide for California Lenders
Nema Daghbandan, Esq. and
One of the most common misunderstood issues our firm comes across is the
basic late charge. Lenders will request that loan documents include a
15% percent late charge with a 5 day grace period, or a late charge on
the entire principal balance when a maturity balloon payment is not paid.
Lenders are often surprised to find out that there are restrictions on
the amount of late charge and the minimum grace period required before
a late charge can be assessed. This article addresses common misconceptions
and limitations of late charges.
Are Late Charges Permissible?
This may appear to be a silly question. Most promissory notes include a
late charge and late charges are the rule not the exception. Late charges
are essentially a contract provision for liquidated damages. The concept
behind a liquidated damages clause is that the potential damages to a
lender are difficult to determine at the time of making the loan. For
example, if a payment is not paid on time, the lender will need to pay
a loan servicer or an employee to follow up with the borrower. The expense
to do so is not always clear and ascertainable at the outset of the transaction,
but there is necessarily an expense.
Under California law, the late charge must bear a reasonable relationship
to the probable loss of the lender resulting from the late payment. An unreasonable late charge is unenforceable as a penalty that punishes
the borrower. California law prohibits punitive damages in contracts. Since the purpose of a late charge is to compensate the lender for any
damages suffered due to the late payment, a late charge that is out of
line with that compensation is interpreted as existing to punish the borrower
for nonperformance and is therefore unenforceable.
Statutory Limitations on Late Charges
The type of license under which a lender originates a loan will determine
whether the loan has a statutory restriction on the late charge. Below
is a sampling of statutory restrictions of late charges:
Default Statutory Limitation (non-licensed loans). When the loan is not originated through any type of license, California
law prohibits a late charge in excess of the greater of 6% of the installment
payment due, or $5. Payments cannot be considered late until at least
10 days following the due date of the installment payment.
Bureau of Real Estate License Originated Loans. If a licensed California broker arranges a loan to a private investor or
directly makes a loan which loan is secured by a 1-4 family residential
property, California code prohibits a late charge in excess of the greater
of 10% of the installment payment due, or $5. Payments cannot be considered
late until at least 10 days following the due date of the installment
payment. The maximum late charge permitted on any balloon payment is the
maximum late charge that could be assessed on the largest single monthly
installment due, and cannot be assessed on the entire balloon payment.
Credit Union Loans. All loans, regardless of collateral type originated by a credit union share
the same limitations as broker originated loans, 10% on the installment
due with a minimum 10 day grace period.
FHA/VA Loans. For FHA/VA loans, the late charge cannot exceed 4% of the delinquent payment
and cannot be collected unless a payment is more than 15 days late.
National Banks. National banks may impose any late charge on California residents that
is permitted by the law of the bank’s home state, even though the
amount exceeds the legal limit in California.
Out of State Loans. Most states regulate and limit late charges. For example, Colorado prohibits
a late charge in excess of 5%, which may only be assessed after a 10 day
grace period for certain consumer credit transactions.
What if my Transaction is not Covered by a Statutory Limitation?
There may be instances in which a statutory restriction does not apply.
For example, a loan which is arranged by a licensed BRE broker but secured
by commercial real property or business purpose loans made by a licensed
California Finance Lender.
When the late charges for a loan are not limited by statute, the Lender
must still charge a fee that is reasonable in relation to the harms incurred
by Lender. The courts in California have determined that the following
late charges were unenforceable as penalties which bore no reasonable
relationship to the harm incurred by Lender.
Garrett v. Coast & Southern Fed. Sav. & Loan Assn. The California Supreme Court held that a 2% late charge assessed on the
principal balance of the loan when a Borrower failed to pay the loan off
at maturity was punitive in character and not reasonably calculated to
compensate the injured lender. The late charge provision was held to be
void, and the Court remanded for an assessment of the actual damages sustained
by the lender.
Los Angeles City School Dist. v. Landier Inv. Co. The California Court of Appeals stated that a late charge provision providing
for a double payment would be unenforceable as a penalty.
Ridgley v. Topa Thrift & Loan. The California Supreme Court held that a late fee disguised as a prepayment
penalty which was equal to six months’ interest, but only due if
the borrower was late was an unenforceable penalty.
Poseidon Development, Inc. v. Woodland Lane Estates, LLC. The California Court of Appeals determined that a 10% late charge on any
“installment” payments could not apply to the balloon payment,
and only applied to monthly interest payments. Otherwise, it would have
been an unenforceable penalty not rationally related to compensating the
lender for the late payment. The Court reasoned that the administrative
costs associated with collecting a late payment for a regular monthly
late payment was $641.67, and the administrative costs to collect on a
maturity default would not have been much greater yet resulted in a $77,641.67 penalty.
Pyramiding of Late Charges
California code prohibits the practice of pyramiding late charges. For example, if a borrower fails to make a timely payment in January,
but makes the regular installment payment due in February, a lender cannot
charge a late charge for February even though the payment received in
February would be applied towards the January payment and the February
installment payment would still be due.
All late charges must be reasonably related to the costs incurred by a
lender even when a loan is not covered by a statutory restriction. In
transactions where statutory restrictions did not apply, the California
courts prohibited (i) late charges as low as 2% assessed on balloon payments,
(ii) multiple months interest charged upon a single late payment, and
(iii) a double payment due when late. When determining a reasonable and
enforceable late charge, lenders must be able to ultimately demonstrate
the actual damages sustained by lenders, and not charge such a high late
fee that could be interpreted as punishing the borrower.
Additional questions or comments? Contact attorney Nema Daghbandan at
firstname.lastname@example.org. Geraci Law Firm is a law firm dedicated to the representation of lenders,
brokers and other real estate professionals. The firm has thirteen attorneys
with experts in securities, lending compliance, document preparation,
litigation and secured creditors rights.
 California Civil Code § 1671
 California Civil Code § 3294
 California Civil Code § 2954.4
 California Business and Professions Code § 10242.5
 California Financial Code § 15001; California Civil Code 2954.5
 12 U.S.C.A. §§ 1701 et. seq.; 38 U.S.C.A. §§3701 et
seq..; 38 C.F.R. § 36.4311(c)
 COLO. REV. STAT. ANN. § 5-2-203(1)
 9 Cal. 3d 731, 511 (Cal. 1973)
 177 Cal. App. 2d 744, (Cal. App. 2d Dist. 1960)
 17 Cal. 4th 970, 953 (Cal. 1998)
 152 Cal. App. 4th 1106, (Cal. App. 3d Dist. 2007)
 California Civil Code § 2954.4