By Tom Standen, Note Servicing Center
[Also see the response to Tom's article in Part II below.]
With respect to the amount, timing and method used to assess and collect late charges, I think in the last 16 years we have seen them all. It doesn’t seem to make much difference whether the note was structured by a CPA, Attorney, Financial Advisor, Title Company, Real Estate Broker or a “do it yourself” seller carry back. There are almost as many variations as there are notes.
It is not my intention to present rules and regulations to drain you of creativity, but as Note Brokers and Note Buyers it just makes sense to know what the law and/or statute has to say about late charges, how much you can charge and how and when you can collect, and how it can affect the value of the note.
Again, please be aware that the laws referred to are California Statues, but have relevance for all states. Check with your state about variations. This explanation is for illustration only. Also, they are far from all inclusive. This would be a study in itself. However, most states have similar laws on the books.
Limited Late Charges
The Business and Professional Code seems to indicate a late charge can apply to any type of property. However, the amount charged on an Owner Occupied, one to four units is limited to 6% after 10 days, and 10% after 10 days on all other loans. The late charge provision must be stated in the note and is limited by Statute. Additionally, you cannot assess a late charge unless you have provided a statement to the borrower identifying when the late charge will be assessed on a monthly basis for each payment.
To satisfy this requirement, payment coupons with such a statement can be used. When using payment coupons, a January-to-January method should be considered. This way you have a standard practice whereby you send an annual accounting statement for all activity of the account for the preceding year, the 1098 Interest Paid form along with coupons for the entire year.
When using payment coupons, they must comply with the “late charge” code sections and include the following:
1. A notice sent for each payment due, the date after which such charge will be assessed and,
2. The notice shall contain the amount of such charge or the method by which it is calculated.
Pyramiding Late Charges
Pyramiding late charges is prohibited. Pyramiding of late charges is where you charge more than one late charge for the same delinquent installment. A default interest rate is one that increases after a certain period of default, and a late charge is being charged would be pyramiding of late charges.
Late charges on balloon payments seem to surface as a “punitive penalty” occasionally. Clearly, the California Business and Professional Code prohibits such a practice except that a late charge that could have been assessed on a regular installment can continue to accrue for each month past the due date.
Another question that seems to frequently arise is: “When is the payment deemed received?” Much controversy exists in this area and many court cases exist. We suggest the following:
a. Do not require payment be made by mail only.
b. Your payment coupons should not contain a limited access mailing address, such as a P.O. Box otherwise you may be responsible for payments placed in the mail.
c. The date payments made by personal check is the date received provided you allow all methods of payment to be made. The mere act of depositing in the mail is not a payment made as supported by the Cornwell v. Bank of America. See Cornwell.
d. The date payments were deposited in the mail for good funds (money order, cashiers check, etc.) is the date deposited in the mail.
The habitual, persistent absence of timely payments from an irresponsible Payor can drive you to drink (or at least up the wall) even when a late payment provision exists in the note. But the situation is exacerbated to total frustration and sends us over the edge when no late payment provision exists in the note.
So, what can we do when considering that statutory limitations do, in fact exist?
First of all, when considering the purchase of a note, consider how the absence of a late charge in the note will negatively affect the value of the note. This should be a factor in the decision making process of how much to pay for the note or in some cases actually could be a determination of whether to buy it or not. As you know, yield is not the sole criteria.
Next, if you are structuring a note or providing consultation, be personally aware of the “rules of the road” and not depend totally on others.
If you are nervous about an unlawful late payment provision in a note that you own and are collecting, you could consider modifying the note. The risk here is that it puts the Payor on notice and you in a potentially vulnerable position. But, maybe only you know that … there are ways you could do some creative negotiations in terms of mutual benefits.
If the borrower were continuously late making monthly payments, an option would be to make a report to a national credit-reporting bureau. Problem here is, the reporting cuts both ways. The credit nick on the borrowers history could negatively affect the value of your note when and if you sell it.
Obviously, we are biased in our suggested solution to the problems of late payments. More Note Brokers and Loan Brokers than you may realize are taking advantage of the aggressive delinquency enforcement provided by a Professional Loan Servicing Company and the well of resources available to them. The entrance of a third party in the collection process typically causes an increase in the compliance with the provision of the note by the Payor. TS
Late Fees Part II
John Moren, Princeton Investments
I wanted to follow up on the article about late charges by Thomas Standen. In speaking with our NoteSmith software users, I sense a lot of confusion and unnecessary creativity concerning late fees around the country. Here are some issues we see in addition to those mentioned in Mr. Standen’s article
Definition. A late fee is a small, state sanctioned fee you collect as reimbursement for the nuisance of processing a late payment. Most states limit the fee to 4 or 5% of the installment amount. It is a one time, flat fee.
Late fee versus interest. IRS Publication 1099 (www.IRS.gov), which is the instruction booklet for completing 1098’s, allows deducting late fees along with interest “unless the late charges are for a specific mortgage service.” A late fee of $10 on a $200 monthly payment easily can be construed as a specific service, namely, sending a late letter or making a collection call. But what about a late fee of $5 per day? First, this is not a single fee and violates Mr. Standen’s warning about pyramiding late charges. It also has a time component which makes the charge sound more like interest than a flat fee. After all, isn’t interest really just a charge per day? If you are looking for an incentive for your payors to make timely payments, a tax-deductible late charge is not the way to go.
Unconscionable fees. We recently received a software question concerning a monthly payment amount of $253.06 that carried a late fee of $150.00 after 4 days. I don’t know which state this was in, the collateral, or whether the payor was a natural person or a corporation (corporate payors generally can be legally and financially gouged without consumer protection). If this note ever makes it into court, a skilled attorney could have a field day with it. To answer their question, one of our support people wanted to call back and ask for the person who would be left behind when the rest of the office was in jail! We bit our tongues and faxed back politely, but more on this note later.
Increasing income without pyramiding-part 1. Almost all notes specify that payments will be applied first to costs of collection, next to interest and the remainder to reduce principal. Let’s again use a $200 monthly payment where about $170 goes to interest, about $30 goes to principal and then a $10 late fee after 10 days. Of course, the payor is 15 days late but sends you $200. We’ve seen servicers apply the first $170 to interest and the remaining $30 to principal. The late fee is accrued as if they expect to collect it someday. Instead, the first $10 needs to go to the late fee, which never can bear interest, then the next $170 to interest, leaving only $20 for principal reduction. The next month, interest will be higher than expected because of the principal shortfall.
Increasing income without pyramiding-part 2. Continuing with the same scenario, the servicer still has a choice to make. Do they close out the month or not? According to the terms of the note, the above payment is a partial payment. If the month is not closed, then $10 is still owed. When the payor makes the next $200 payment, even if it’s on time, the first $10 goes to close out the previous month and this payment is now $10 short-and subject to a late fee if not paid within the 10-day grace period. This seems to be pyramiding because each subsequent “timely” payment ends up with a late fee, but it is not. Only one late fee is charged per payment. Payments are not timely unless the entire payment is received timely. I have never seen a note that specified the monthly payment amount could be “around $200.” It always says “$200 or more.”
Grace periods. The whole notion of late fees opens up a legal can of worms and here is the argument. Since the payor has a grace period of 10 days, the note specifically states that it is acceptable to pay at least 10 days late. Further, it implies permission to pay even later since the late fee is the payment in full for the right to make a payment after the grace period expires. Some of our users do not write late fees into their notes because they are afraid it may inhibit foreclosure efforts.
Late fees are not the punishment. Punishment is designed to modify behavior. A late fee is not the big stick, foreclosure is. A late fee is merely reimbursement of the costs of collection. The threat of foreclosure is the punishment that forces timely payment. Going back to late fee accruals, if you’ve been shorted repeatedly on the principal necessary to amortize the loan, you are in a foreclosable situation. If you’ve been politely applying the payments first to interest and principal, while accruing non-interest bearing late fees, it is doubtful whether you could foreclose. Would you rather go before the clerk of the court-or the court itself-with outstanding principal or outstanding late fees?
Good clauses don’t make good notes, good payors do. I heard this once at a Jimmy Napier seminar and we’ve been upgrading our portfolio ever since. All the creativity, punishment and coercing you can muster is in vain if the payor does not have the financial wherewithal, or the mental desire, to make a payment. Remember the $253.06 payment with the $150.00 late fee? The check bounced.