Grace Period Definition – Loan Basics
What Is a Grace Period?
A grace period is a set length of time after the due date during which payment may be made without penalty. A grace period, typically of 15 days, is commonly included in mortgage loan and insurance contracts.
How a Grace Period Works
A grace period allows a borrower or insurance customer to delay payment for a short period of time beyond the due date. During this period, no late fees are charged, and the delay cannot result in default or cancellation of the loan or contract.
Payment after the due date but during the grace period does not cause a black mark to be added to the borrower's credit report.
- Borrowers can use a grace period to pay a late bill without negative impact.
- A mortgage loan usually offers a built-in grace period.
- If a loan or other agreement has a grace period, its length of time will be noted in the contract.
However, it's important to check a contract for the specifics on the grace period. Under some loan contracts, no additional interest is charged during the grace period, but the majority add compounding interest during the grace period.
When defining a grace period on a loan, it is important to note that credit cards do not have grace periods for their monthly minimum payments. A penalty for late payment is added immediately after the due date and interest continues to be compounded daily.
A payment after the due date but during the grace period does not cause a black mark on the borrower's credit report.
However, the term grace period is used to describe one scenario in consumer credit. That is, a period of time before which interest may be charged on new purchases on a credit card is called a grace period. This grace period of 21 days is meant to protect consumers from being charged interest on a purchase before the monthly payment is due.
Examples of Grace Periods
If a consumer has a mortgage with a due date on the fifth of every month, and the contract has provided a five-day grace period, the payment can be received as late as the 10th of the month without the borrower incurring any penalties. This is an example of a loan grace period in a mortgage loan.
The grace period for credit card purchases is a newer phenomenon and was established with the Credit Card Act of 2009. Before that consumer protection law went into effect, some lenders began charging interest on purchases immediately after they were made.
Even a consumer who paid off a new purchase in full by the next payment date would be charged interest before the bill was even received. The act includes a provision that requires credit card issuers to give a grace period of at least 21 days for the borrower to repay the charge without incurring any interest charges on the purchase.
Notably, this grace period does not necessarily apply to cash advances or balance transfers. The terms of these are detailed in the credit card agreement.
Any contract that has a grace period will also include language that explains what will happen if the payment is not made by the end of that period. Penalties can include a late payment fee, a penalty interest rate hike, or the cancellation of a line of credit. In cases where an asset is pledged as collateral, multiple payments can result in the seizure of the asset by the financial institution.