What Is A Grace Period?
A grace period is a period after the deadline for a payment in which the payment can be made without resulting in a late fee. They usually last around 15 days and are commonly seen in loans and contracts.
When a borrower misses the initial deadline but makes the payment during the relief period, the initial missed payment will not negatively affect the borrower's credit score.
All contracts are different, and this includes their clauses about grace periods. Sometimes, no additional interest is charged during this time, but other contracts add compound interest. Ensure you check your contract so you don’t accrue much interest.
It’s also crucial not to assume every loan situation has this relief. Some loans, like credit cards and monthly minimum payments, don't have this luxury, and a penalty for late payment is added immediately after the deadline.
Compounded interest will continue to accrue daily.
Any contract that includes this period of relief will explain what will happen if you have not been paid by the end of the period. After this point, there will likely be penalties.
These penalties may include late payment fees,punitive interest rate hikes, or cancellation of credit lines
Sometimes this period is referred to as a “forgiveness period,” but that wouldn’t be accurate. During this period, debt obligations are not forgiven; rather, they’re postponed to a later date. Borrowers are still expected to make the payment during this time.
Key Takeaways
- A grace period is a set length of time after the due date during which a payment can be made without penalty. It is commonly associated with loans, credit cards, and insurance policies.
- The duration of the grace period can vary depending on the financial product and the terms set by the lender or service provider. Common lengths range from a few days to a month.
- While a grace period can prevent late fees, consistently missing due dates even within the grace period can affect credit scores if reported to credit bureaus.
- A grace period does not mean a payment due date extension. Payments should still be made as close to the due date as possible to avoid any negative repercussions.
Understanding Grace Period
The duration of the grace period will vary widely depending on the contract. During this time, borrowers can make a “late” payment without facing any financial consequences.
The periods of temporary relief are most commonly seen in installment loans. An installment loan is a lump sum of money that an individual borrows and repays over time in payments (usually monthly or annually).
Installment loans can either be secured with collateral, like a house with mortgage payments, or unsecured, where individuals don’t put up collateral.
These loans are already in place to give you more time to make payments, so a temporary relief period is just an addition.
The most common installment loans are student loans, mortgages, and automobile loans, but any loan paid off using “installments” is considered an installment loan. Although these relief periods are not necessarily required when contracting with loans, most lenders will still include them in the mix.
Sometimes, if you don’t make your payments and put up collateral, the financial burden falls on the lenders.
This is why lenders like to give borrowers time to get the required financial resources to pay off the loan, leading to fewer headaches for the lenders.
But ensure if your lender gives you this relief period, you make the payment by the given date because if you don't, you could face some nasty financial consequences. These will be much worse than the amount of money it takes to make the payment.
Potential Penalties
When individuals still miss the payment at the end of the relief period, many borrowers are penalized. This penalty ensures the borrowers don’t abuse the system.
Late fees are the only thing that borrowers need to worry about if they don’t pay by the time the grace period expires. There may be other consequences, such as
- Interest rate hike: If an individual misses a payment, the go-forward interest rate could increase. A lender can instill an interest rate hike on future loan payments if the payment isn’t satisfied by the end of the temporary relief period.
- Collateral seizure: Collateral is used to secure a loan and is something of value you place as a safeguard in case you don’t make payments. If you miss payments, the lender will seize and own this asset.
- For example, if an individual doesn’t make the payment after the final deadline, the lender can seize the property on which the individual is paying the mortgage.
- Negative impact on credit score: When you pay late or miss a loan payment, your credit score will be negatively affected. Low credit scores hurt individuals’ ability to get future loans and credit cards because they are considered risky applicants.
Grace Period's Effect on Credit
When individuals handle their financial obligations during the relief period, their credit scores will not be negatively affected. If the principal doesn’t accrue interest during the period, it may be favorable to wait until the relief period to meet the financial obligation rather than the initial date.
With no interest accruing over the period, individuals can effectively delay payment and have more flexibility with their finances. This might allow for opportunities to use the money better and more effectively than initially paying off the bill.
Most credit card companies will have this period for their customers. If your company gives a relief period and you aren’t carrying a balance, you can avoid paying interest on any new purchases if you pay your full amount by the due date.
Credit card companies operate on billing cycles, which apply to the grace periods they award. There are two important dates when looking at the billing cycle of a credit card:
- The closing statement date:During this date, the credit card company totals up your spending and activity over the month to generate yourcredit card statement. The statement will be available for individuals online or through the mail.
- The payment due date:According to federal law, each individual’s payment due date must fall on the same day every month and be 21 days after the statement closing date.
Credit card bills will show two important figures: the statement balance and the minimum payment. The statement balance is the total amount you owe on the closing date.
The minimum payment is the least amount you must pay towards the bill if you don’t want a late fee.
So how does this connect to grace periods? If you pay your entire statement balance by the due date, a grace period will occur during the next billing cycle. Once the period starts, individuals will not be charged interest on any new purchases until the next due date.
To keep it simple, the credit card company is lending you free money.
This cycle can keep recurring. If you pay the full amount of that cycle’s bill by the due date, the grace period renews for another cycle. If you keep following this routine, credit card interest will never be a concern.
Grace Period vs. Deferment Period
At the surface level, a loan deferment seems similar to a grace period, but these two forms of relief are different. A deferment is a period during which borrowers aren’t required to make loan payments. It is usually granted to borrowers who face financial hardships.
Unlike grace periods, deferment isn’t usually automatically applied after the due date of payment. Generally, borrowers must apply for deferment and provide evidence as to why they cannot carry out the payments at the time.
An exception to this rule isfederal student loans, which are automatically deferred when an individual enrolls at least half-time in a university degree program and completes a half-time course load.
Most of the time, loans will continue to accrue interest while deferred, so it may be smart to contribute as much as you can financially during this period so you don’t pay too much more than the principal. To summarize the differences quickly, we can look at the chart below:
| Grace Period | Deferment |
|---|---|
| Most common in installment loans, like mortgages or personal loans. | Some loans are automatically deferred, like student loans. |
| Depending on the contract, interest may or may not accrue during the period. | Deferment is never guaranteed. |
| Already built into the loan agreement (something you don’t have to apply for) | Most of the time, deferments will require proof of financial hardship to be granted. |
Due to interest accruing over the period, it more significantly impacts your financial health. |
Grace Period FAQs
It’s important to use this temporary relief period to set yourself up to afford the payments once the period ends financially. This may look like applying and getting a new job or enrolling in a higher education program.
Some different types of loans are set up to allow new borrowers (i.e., students) time to get situated and have an established source of income before they require them to pay off the debt.
Usually, lenders allow around six months when giving relief to their lenders. The period is usually specified in the contract. Some lenders are more forgiving than others, so check your contraband and consult your lender about the length of the relief.
The payment is only considered late if you make it after the allotted temporary relief period. The payment is not considered late during the period.
If you are late on your payment, this may result in punitive action, like interest or a late fee. The amount you’ll pay on a late fee solely depends on your contract and the type of loan you are taking out. Sometimes late loan payments are limited by state law.
Free Resources
To continue learning and advancing your career, check out these additional helpfulWSOresources:
- Priority Sector Lending Certificates (PSLCs)
- Quality of Collateral
- Risk Rating Models
- Sales Risk
- Signature Loan
