Default Interest Rate

A default interest rate is an increased rate that applies once a borrower is in default. The promissory note or loan agreement sets it, usually as the regular rate plus a fixed margin, and states when it starts and stops. Common triggers include a missed payment past a grace period, failure to pay at maturity, a covenant breach or a bankruptcy filing.

Using hypothetical numbers: a $1,000,000 loan carries an 8% rate, with a default rate of the regular rate plus 5 percentage points. Normal daily interest is about $219 ($1,000,000 × 8% ÷ 365). At 13%, it is about $356 a day. So each day the default continues costs the borrower roughly $137 more.

A default rate is different from a late fee. A late fee is a one-time charge on a missed payment. Default interest applies to the outstanding balance, often the whole loan, for as long as the default lasts. Many loans have both.

Why it matters for lenders

A loan in default costs more to manage and carries more risk. The default rate offsets some of that and pushes the borrower to cure quickly.

It is not automatic, though. Courts in the US look at whether a default rate is a fair estimate of the lender's added cost or an unfair penalty. Results vary by state and by facts, and bankruptcy courts examine default interest closely. State usury limits can also cap the total rate on some loans. Lenders should work with counsel on how these clauses are written and used.

Applying it also takes accuracy. Default interest must start on the right date, accrue on the right balance and stop when the default is cured. Errors can lead to disputes, refunds and a weaker position in a loan workout.

How it works in practice

A private lender's borrower misses the maturity date on a bridge loan. The loan is now in default. The asset manager checks the note: the default rate applies from maturity, and a written notice is required. The notice goes out and is saved on the loan.

The servicing team switches the loan to the default rate as of the maturity date. Daily interest now accrues at the higher rate and shows separately from regular interest. When the borrower asks for a payoff statement a month later, it lists both amounts. The credit officer may agree to waive part of the default interest as part of a settlement. That waiver is approved and recorded.

In spreadsheets, default interest is often added late, calculated on the wrong balance or waived by email with no record. Keeping the trigger date, rate and approvals on the loan makes them defensible.