Borrower Beware: Lenders May Impose Late Charges on Balloon Payment of Maturing Loan if not Paid Timely
February 11, 2009
As the credit crisis continues to spread, refinancing existing mortgages has become increasingly difficult. With far fewer lenders making loans and those that are having much stricter underwriting criteria, many borrowers may have difficulty finding lenders to take out their existing financing, or at the very least, may be significantly delayed in finding a replacement lender.
This is exactly what happened to a client of ours recently, who was unable to find a new lender to refinance an existing mortgage with a substantial balloon payment until three months after the loan matured. When we requested that the old lender provide a payoff statement, the lender demanded a 5% late charge on the balloon payment. Since the balloon amounted to over $900,000 on what was originally a $1,100,000 loan, the lender was looking for a late fee of over $45,000. The lender was demanding this fee despite the fact that our client had continued to make the regular monthly payments due prior to maturity.
As you can imagine, our client was outraged at what seemed to be an unreasonable money grab by this lender. However, as the lender pointed out, the note which our client had signed provided if “any payment” was not received on or before the date due, that Borrower had to pay the 5% late charge.
Law on Enforceability of Late Charges Varies
The law on whether a lender is entitled to a late charge on a balloon payment at maturity is not clear, and case law has come out on both sides of the issue. The one Indiana case which addressed the enforceability of a late charge on a balloon payment held that the late charge only applied to the monthly payments based on an interpretation of the specific late charge provision in the Note.
Assuming the Note is otherwise clear that the late payment charge applies to any late payment, courts have traditionally used a two-part test to determine whether the late payment charge is enforceable. This is the test generally used by courts to determine whether a so-called “liquidated damages” provision is valid or constitutes an unenforceable penalty. First, in order to be enforceable, the potential damage the lender would suffer from the late payment must be difficult to ascertain. Second, the late charge must be a reasonable estimate of the potential damage the lender might suffer. Using this two-part test, courts in New York and New Jersey have upheld 5% late charges on balloon payments due at maturity.
While Ohio courts have not specifically addressed the enforceability of similar late charge provisions, they have adopted this test in analyzing whether liquidated damage provisions are enforceable. However, the Ohio Supreme Court has adopted a third factor in its analysis: namely that the late payment provision cannot be so disproportionate to the actual damage suffered that it would not have been the party’s intent to apply such a provision.
In this case, we pointed out to the lender that the lender had suffered no real damages in light of our client’s having continued to make the regular payment and his willingness to pay default interest following maturity. Ultimately, the lender agreed to a substantial reduction in the late charge.
Lessons to be Learned
The circumstances which our client faced teach a few important lessons.
This is exactly what happened to a client of ours recently, who was unable to find a new lender to refinance an existing mortgage with a substantial balloon payment until three months after the loan matured. When we requested that the old lender provide a payoff statement, the lender demanded a 5% late charge on the balloon payment. Since the balloon amounted to over $900,000 on what was originally a $1,100,000 loan, the lender was looking for a late fee of over $45,000. The lender was demanding this fee despite the fact that our client had continued to make the regular monthly payments due prior to maturity.
As you can imagine, our client was outraged at what seemed to be an unreasonable money grab by this lender. However, as the lender pointed out, the note which our client had signed provided if “any payment” was not received on or before the date due, that Borrower had to pay the 5% late charge.
Law on Enforceability of Late Charges Varies
The law on whether a lender is entitled to a late charge on a balloon payment at maturity is not clear, and case law has come out on both sides of the issue. The one Indiana case which addressed the enforceability of a late charge on a balloon payment held that the late charge only applied to the monthly payments based on an interpretation of the specific late charge provision in the Note.
Assuming the Note is otherwise clear that the late payment charge applies to any late payment, courts have traditionally used a two-part test to determine whether the late payment charge is enforceable. This is the test generally used by courts to determine whether a so-called “liquidated damages” provision is valid or constitutes an unenforceable penalty. First, in order to be enforceable, the potential damage the lender would suffer from the late payment must be difficult to ascertain. Second, the late charge must be a reasonable estimate of the potential damage the lender might suffer. Using this two-part test, courts in New York and New Jersey have upheld 5% late charges on balloon payments due at maturity.
While Ohio courts have not specifically addressed the enforceability of similar late charge provisions, they have adopted this test in analyzing whether liquidated damage provisions are enforceable. However, the Ohio Supreme Court has adopted a third factor in its analysis: namely that the late payment provision cannot be so disproportionate to the actual damage suffered that it would not have been the party’s intent to apply such a provision.
In this case, we pointed out to the lender that the lender had suffered no real damages in light of our client’s having continued to make the regular payment and his willingness to pay default interest following maturity. Ultimately, the lender agreed to a substantial reduction in the late charge.
Lessons to be Learned
The circumstances which our client faced teach a few important lessons.
- First, if you are faced with a maturing note and have not secured a new loan to refinance it, continue to make the monthly payments that were due prior to maturity. Certainly this helped our argument that the lender had suffered no real damage as a result of the late payment at maturity, or certainly not enough damage to make a 5% late charge in any way proportionate to the damage suffered.
- Secondly, in negotiating late charge provisions in new loans, make sure that the late charge only applies to monthly payments and not to balloon payments at maturity. While many lenders consider their late charge provisions sacrosanct and may at first be unwilling to negotiate this change, the purpose of the late charge provision is to compensate the lender for the administrative burden of dealing with late payments. A reasonable lender should recognize this and be willing to limit late charges to late monthly payments.
- Finally, if you are in a situation where you think you may be faced with a substantial late payment charge like this, request a payoff letter as soon as possible so that you have time to deal with it as early as possible and not with the potential gun to your head of an expiring commitment on the new loan.
