What is Grace Period And How it Works?

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 loans and insurance contracts.

Summary

  • A grace period is a period after the deadline for a financial obligation where a late fee is waived if the financial obligation is satisfied within that period.
  • The grace period duration varies depending on the contract and debt instrument but is usually 15 days.
  • Satisfying a financial obligation during the grace period will not negatively impact an individual’s credit score.
Grace Period

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.

However, it’s important to check the 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 compound 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.

However, the term grace period is used to describe one scenario in consumer credit: 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.

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Grace Period and its Impact on Credit score

According to consumer credit reporting company Experian, individuals who satisfy their financial obligation during the grace period will not see their credit score adversely impacted. If interest does not accrue during the grace period, it may be favorable for individuals to satisfy their financial obligation during the grace period rather than at the initial deadline.

Typical Grace Period for a Mortgage

A grace period for a mortgage varies from lender to lender but typically lasts around 15 days from your payment due date. That means if your mortgage payment is due on the first of every month, you’d have until the 16th of the month to make your payment without penalty.

As long as you make your payment within the grace period outlined by your lender, your creditor won’t be able to charge you any late fees. Late payment fees on mortgages can range from 3% to 6% of the monthly payment amount, depending on the local laws and lender.

Since grace periods vary depending on the lender, make sure to check your mortgage documents to find out how many days you have before you’re hit with a late payment penalty.

Grace Period for a Credit Card

For credit cards, grace periods are defined slightly differently. Credit card grace periods don’t protect you from late fees like with mortgages, but rather they give you time to pay your balance in full without being charged interest on your purchases. Typically, the grace period on your credit card is the time between the end of your billing cycle and the day your payment is due.

While credit card companies are not legally required to give you a grace period, many issuers do. Grace periods for credit cards will vary depending on the card issuer, but federal law requires that credit card companies send you your bill within 21 days of the payment due date, which means that you’ll have at least 21 days’ notice of how much you owe for that billing period.

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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.

What happens after the grace period?

If you continue to carry a balance after the grace period ends, you will be charged interest at the regular purchase APR (unless your card offers an intro 0% APR period). For example, if you have a credit card with a 16.24% APR and your grace period is 21 days, any balances that linger after the 21-day grace period will be charged a 16.24% APR.

You could be hit with a late fee on top of interest charges if you don’t make at least the minimum payments before the grace period ends.

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Potential Penalties

In addition to late fees that must be paid if a financial obligation is not satisfied before the end of the grace period, there may be other consequences, which may include:

Interest rate hike: The go-forward interest rate may be increased if a payment is missed. For example, if a mortgage payment is unsatisfied before the end of the grace period, the lender may have the option to instill an interest rate hike on future mortgage payments.

Seizure of collateral: The lender may seize assets pledged as collateral if a financial obligation is outstanding for an extended duration. For example, if a mortgage payment is unsatisfied months after the end of the grace period, the lender may have the option to seize the property.

Damage to credit score: Missing a payment, or paying late, will generally negatively impact an individual’s credit score. A low credit score may impact an individual’s ability to secure credit at favorable rates.

Grace Period vs. Deferment

Similar to grace periods, a deferment is a period of time in which a borrower is not required to make payments on a loan, usually in cases of financial hardship. Unlike grace periods, deferment is usually not automatic; borrowers typically have to request or apply for a deferment and provide documentation to show why they are unable to make payments. In most cases, loans continue to accrue interest during a deferment, so it is wise to make any payments that you can during these periods.