Read on for a review of late charge basics, plus information on the effects the new consumer mortgage rules have on late charges.
Elements of a late charge
Promissory notes typically contain a late charge provision. The late charge provisioncalls for an additional charge if payment is not received by the mortgage holder when due or within a grace period after which the payment is delinquent.
To establish the right to collect a late charge, the following conditions need to exist:
- a late charge provision is contained in the note [See first tuesday Form 418-1];
- a scheduled payment is delinquent;
- a notice of amounts due is delivered by the mortgage holder assessing the late charge and requesting its payment, if the delinquency is the first; and, for a subsequent delinquency, notice is given or accounting requirements for semi-annual and annual reports have been met; and
- the dollar amount of the late charge is within the limits set by statutes or reasonableness standards.
An owner’s failure to pay a late charge when demanded is not a material breach of the note and trust deed. As a non-material breach, the failure to pay a late charge alone is not grounds for the mortgage holder’s initiation of foreclosure by recording a notice of default (NOD).
The negotiation of a late charge provision
Late charge provisions included in notes used by institutional lendersare generally non-negotiable. This non-negotiable status is due primarily to adherence to established uniformities, such as ceilings set by statute or pooling arrangements in the secondary mortgage market. All too often, retaliation becomes the basis for setting the charge. When excessive, it becomes windfall earnings for the mortgage holder.
However, late charge provisions in private money or carryback transactions are not automatic or boilerplate. Instead, late charges are left to negotiations between the participants in the transaction and judicial oversight.
A late charge provision in a mortgage needs to be agreed to by inclusion in the note. When a late charge on a seller carryback debt is agreed to in a purchase agreement, escrow is instructed to include a late charge provision in the note they prepare. [See ft Form 150 §8.1]
The complete late charge provision and amount
A complete late charge provision includes:
- the amount of the late charge;
- the duration of any grace period following the due date before a payment is considered delinquent; and
- a requirement for notice from the mortgage holder to impose the late charge and demand its payment on a delinquency. [See ft Form 418-1]
To be enforceable, a late charge amount imposed for a delinquent payment on a debt secured by real estate must be reasonably related to money losses incurred by the mortgage holder due to the delinquency. The charge may not be punitive in amount, as in an effort to coerce timely payment. [Calif. Civil Code §1671; See ft Form 418-1 §2.1]
While late charge provisions are triggered by the delinquency of a payment, the agreed-to charge is not automatically due. Unless the first delinquency is immediately preceded or followed by a notice imposing the charge and demanding its payment, the charge is waived.
For all following delinquencies, lack of notice and demand does not automatically waive the late charge. Instead, the mortgage holder has the option to either:
- provide the notice and demand payment of the late charge; or
- assess the charge automatically, and account for assessed late charges semi-annually. [CC §2954.5]
Special periodic accounting rules apply to consumer mortgages, which are discussed later.
Reasonable monetary losses collectible as a late charge include:
- the actual out-of-pocket expenses incurred in a reasonable collection effort; and
- the lost use of the principal and interest (PI) portion of the delinquent payment until paid.
Money losses incurred in a reasonable effort to collect a late payment include the cost of:
- envelopes and postage for mailing the notice; and
- the administrative time spent by individuals in the collection effort prior to recording an NOD.
A late charge provision constitutes a penalty amount when the charge is excessive and not reasonably related to the money losses incurred by the mortgage holder. Here, the borrower is still liable for the mortgage holder’s out-of-pocket money lossesresulting from the delinquency, if assessed and payment demanded—but is not liable for any amount beyond that which is deemed excessive. [Garrett v. Coast and Southern Federal Savings and Loan Association (1973) 9 C3d 731]
When a scheduled payment is not received prior to becoming delinquent, a late charge provision calls for either or both:
- an additional one-time fixed fee stated as a dollar amount; or
- the accrual of interest on the amount of the delinquent PI payment from the due date until the date payment is received. [See ft Form 418-1]
Late charge notice
To collect a late charge for the first delinquent payment on a mortgage encumbering any type of real estate, the mortgage holder needs to first notify the owner in a timely manner of the charge and make a demand for its payment.
Mortgage holders give notice and make a demand for the late charge by providing the borrower either:
- a billing statement or notice sent for each payment prior to its due date stating the late charge amount and the date on which it will be incurred; or
- a written statement or notice of the late charge amount sent concurrent with or within ten days of mailing a notice to cure a delinquency or within ten days after mailing the notice. [CC §2954.5(a)]
The notice of amounts due or the billing statement addressing the first late charge needs to include either:
- the exact amount of the late charge; or
- the formula used to calculate the charge. [CC §2954.5(a)]
If the mortgage holder fails to initiate collection of the first late charge by a demand for its payment, the mortgage holder waives its right to collect a late charge on that individual payment. However, failure to give notice and demand a late charge on a particular delinquency does not waive the mortgage holder’s right to enforce the late charge provision and collect a fee on future delinquencies. [CC §2954.5(e)]
For all subsequent delinquent payments, the mortgage holder is not compelled to notice and demand the late charge to enforce the late charge provision. Instead, it has the option to provide notice and demand payment, or to provide at least a semi-annual accounting of the total amount of late charges assessed during the accounting period. [CC §2954(b)]
Further, overriding consumer mortgage rules for late charges and grace periods which provide greater consumer protection apply. These additional rules, which illustrate the federal preemption of less stringent state law, are discussed below.
Late charges on high-cost consumer mortgages
Late charge limits are unique for high-cost consumer mortgages (Section 32 mortgages). Section 32 mortgages are:
- first trust deed consumer mortgages;
- secured by the owner’s principal residence; with
- an original principal balance exceeding $50,000; and
- an annual percentage rate (APR) exceeding the average prime offer rate for comparable mortgages by 6.5% or more.
To be enforceable, Section 32 mortgage late charges are:
- specifically agreed to in the note;
- not incurred if payment is received within a 15 day grace period after the due date [12 CFR §1026.34(a)(8)(ii),(iii)];
- limited to 4% of the amount of the delinquent principal and interest payment; and
- imposed once for any single delinquent payment that remains unpaid. [12 CFR §1026.34(a)(8)(i)]
Further, holders of consumer mortgages on the owner’s principal residence, including Section 32 mortgages, may not charge a late fee for the owner’s failure to pay a previously demanded late fee, a practice known as pyramiding. [12 CFR §1026.36(c)(2)]
Grace period and late charge controls
On consumer mortgages which do not meet the Section 32 high-cost threshold, Regulation Z (Reg Z) does not control late charges. However, state law does control the amount of a late charge. Several specific rules apply to different mortgage situations.
The late charge on any mortgage (consumer or business) secured by an owner-occupied single family residence (SFR) is limited to the greater of:
- 6% of the delinquent principal and interest installment; or
- $5. [CC §2954.4(a), (e); see ft Form 418-1 §2.1]
Also, the minimum grace period before a mortgage encumbering a one-to-four unit, owner-occupied residential property is delinquent is ten days after the due date without receipt of the payment—even if the borrower agrees to a shorter grace period or no agreed-to grace period is stated. [CC §2954.4(a), (b)]
Consider a lender who originates a purchase-assist mortgage encumbering residential real estate the buyer acquires as their principal residence. The mortgage calls for monthly installments of principal and accrued interest (PI) to be paid on the first day of each month. The mortgage is not made or arranged by a broker.
The note contains a late charge provision allowing:
- a ten-day grace period after the due date for each monthly payment before it is delinquent; and
- a late charge of 6% of the delinquent PI installment on written notice and demand for its payment. [See ft Form 418-1 §2.1]
A monthly payment is not received by the mortgage holder on the eleventh day of the month.
The lender sends the buyer a written notice of amounts due and demands payment of the delinquent installment and the agreed-to 6% late charge.
The buyer makes the delinquent payment but refuses to pay the late charge.
Is the lender’s demand for the late charge enforceable?
Yes! The installment was not received by the expiration of the ten day grace period following the due date of the installment. Thus, the payment is delinquent and a late charge is collectible on notice and demand.
Mailed monthly payment
What if a late mortgage payment is post-marked within the grace period but is physically received by the mortgage holder after the grace period expires?
Mailing the installment within the grace period does not qualify the payment as timely paid.
The payment needs to be actually received by the mortgage holder or servicing agent no later than the last day of the grace period. [Cornwell v. Bank of America National Trust and Savings Association (1990) 224 CA3d 995]
The mortgage holder and buyer may negotiate for the buyer to tender payment by a particular method, such as by mail. When mail is agreed as the method for transmission of payment, the payment is considered received when the owner complies with the method of payment, such as placing the payment in the mail — even if the mortgage holder never receives it. [CC §1476]
Late charge for a mortgage made or arranged by a broker
When a licensed real estate broker makes or arranges a mortgage, the owner-occupied SFR late charge limitation of 6% does not apply. Further, reasonableness standards do not apply either. Instead, statutes control. [CC §2954.4(e)]
For all mortgages secured by any type of real estate which are made or arranged by a real estate broker—other than Section 32 mortgages—the maximum late charge permitted on delinquent monthly payments is the greater of:
- 10% of the delinquent principal and interest payment; or
- $5. [Bus & P C §10242.5(a); see ft Form 418-1 §2.2]
Consider a borrower who enters into a consumer purposes mortgage arranged by a broker. The security for the consumer mortgage is a one-to-four unit residential property, which is the borrower’s principal residence. Additionally, the mortgage exceeds $50,000 and has an interest rate in excess of the average prime offer rate by more than 6.5%.
In this situation, late charge provisions are governed by Section 32 of Reg Z since the debt meets the criteria for a Section 32high-cost consumer mortgage.
Thus, the maximum late charge on a delinquent Section 32 mortgage payment is limited to 4% of the delinquent principal and interest installment. In this situation, the 10% late charge for all other broker-made or arranged mortgages does not apply since the federal rule is more protective of the consumer and therefore controls. [12 CFR §1026.32 (a); 12 CFR §1026.34(a)(8)]
Final/balloon payments untimely paid
Mortgages with a final/balloon payment provision—when allowed—may demand an agreed to late charge on the final/balloon payment if not received within ten days after its due date. [See ft Form 418-1 §2.4]
Editor’s note — Final/balloon payments for consumer mortgages are rare. Qualified mortgages (QMs) provide lenders with the security of presumed compliance with ability-to-repay (ATR) rules. However, final/balloon payments are limited in use to mortgages originated by small lenders operating in rural or underserved areas. Non-QM consumer mortgages may contain final/balloon payment provisions subject to ATR rules.
On the delinquency of a final/balloon payment to pay off the mortgage, the mortgage holder may enforce a default rate provision which increases the note rate on the remaining principal. [Southwest Concrete Products v. Gosh Construction Corporation (1990) 51 C3d 701]
However, if the mortgage is secured by an owner-occupied SFR or is a brokered loan, the default rate provision is unenforceable as the late charge is limited to:
- the greater of $5 or 6% of the delinquent PI installment, in the case of an owner-occupied SFR not made or arranged by a broker; or
- the greater of $5 or 10% of a regularly scheduled PI installment, in the case of a brokered loan. [Bus & P C §10242.5(b), (c); CC §2954.4]
Additionally, any late charge on a final/balloon payment may be charged for each month the payment remains delinquent. Interest at the default rate accrues and is payable with the final/balloon payment.
However, the default rate of interest is limited by reasonableness standards and triggered only by the expiration of any grace period for delivery of the final payment. [Bus & P C §10242.5(c); CC§1671; see ft Form 418-1 §2.5]
One charge per delinquency
For consumer mortgages secured by the owner’s one-to-four unit principal residence, the mortgage holder is not permitted to assess more than one late charge per delinquent monthly installment, no matter how many months the payment remains delinquent.
Additionally, pyramiding is prohibited. Thus, a late charge on a consumer mortgage may only be charged on principal and interest payments, not on unpaid late charges. [12 CFR §1026.36(c)(2)]
Consider a homeowner who fails to make the January and February installments on their consumer mortgage.
The mortgage holder charges the homeowner a late fee for each of the following months the payment remains unpaid, demanding two late charges for the January payment and one for the February payment.
The homeowner pays one installment in March before the 10-day grace period expires.
The mortgage holder’s accounting program applies the payment to the delinquent principal and accrued interest (PI) installment due in January, and demands payment of additional late charges for the failure in March to timely pay the February and March installments.
Here, the mortgage holder is only permitted to collect two late payment charges, no matter how many months pass before catching up the missed payments:
- one for the unpaid January installment;
- one for the unpaid February installment; and
- none for March, since the March installment was timely paid. [CC §2954.5]
A payment received in the month following an unpaid, delinquent installment is applied toward the most recent payment due for late charge purposes, not the most outstanding delinquent installment. The charge is for the one missed installment which still remains unpaid by the homeowner. [CC §2954.4(b); Bus & P C §10242.5(b)]
However, for accounting purposes, funds from the most recent payment are applied to the interest accrued for the month of the oldest delinquency.
An impound account is a money reserve funded by the property owner and maintained by the mortgage holder, also called an escrow account.
The money in the impound account consists of funds the property owner advanced to the mortgage holder as an initial deposit, followed by regularly scheduled further deposits made with monthly principal and interest payments. The impound funds belong to the owner and are disbursed by the mortgage holder for periodically recurring property expenses, such as taxes.
Editor’s note: Reg Z mandates impound accounts for first trust deed consumer mortgages classified as higher-priced (not to be confused with a Section 32 high-cost mortgage). A higher-priced consumer mortgage is secured by the borrower’s principal residence and has an annual percentage rate exceeding the average prime offer rate by 1.5% for comparable conforming mortgages or 2.5% for mortgages exceeding the conforming mortgage limit set by Freddie Mac. By default, Section 32 high-cost mortgages need to conform to the higher-priced mortgage rules. [12 CFR §1026.35]
From the impounded funds, the mortgage holder pays specified obligations the owner periodically owes on the property, such as:
- property taxes;
- insurance premiums;
- assessments for common area or easement maintenance;
- water stock; or
- bonded improvements.
To fund the impound account, a pro rata amount of anticipated costs for annual taxes and insurance premiums (known as TI) is collected with each monthly PI payment (collectively known as PITI).
The TI portion of the owner’s monthly PITI payment is excluded from the computation of any late charge amount.
Enforcement of the late charge
A borrower’s refusal to pay a late charge when demanded does not justify a call of the mortgage or initiation of foreclosure by itself. [Baypoint Mortgage Corporation v. Crest Premium Real Estate Investments Retirement Trust (1985) 168 CA3d 818]
A mortgage holder is not entitled to foreclose on an owner who has tendered all installments which are due, but has failed to pay outstanding late charges. Collection of late charges, when no other monetary breach exists, is not a material breach and is enforced by means other than foreclosure.
Periodic mortgage statements
Holders and servicers of consumer mortgages provide the property owner with a periodic mortgage statement each billing cycle—the regular interval between the scheduled due date of each payment. If the billing cycle is shorter than 31 days, such as a bi-weekly payment schedule, the mortgage holder provides one statement for all cycles occurring in the 31-day period. [12 CFR §1026.41(a)(2)]
The periodic mortgage statement details amounts due and any fees and charges incurred, as well as a breakdown of how the last payment was applied to the principal balance and interest and how payments have been applied year-to-date. A breakdown of any late charges paid and owed is also included. [12 CFR §1026.41(d)(2), (3)]
Small consumer mortgage holders (those who hold fewer than 5,000 mortgages), carryback sellers and business mortgage holders are not required to give periodic mortgage statements under Reg Z. [12 CFR §1026.41(e)(4)]
However, even though small lenders, business mortgage holders and carryback sellers are exempt from Reg Z mortgage statement requirements, they are still required to account for assessed late charges if they do not notify the borrower of late charges at the time they are incurred. [12 CFR §1026.41(e)(4)(ii)(a)]