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Default interest is the part of a private loan that borrowers read last and regret most. It is worth understanding before signing.
Why contracts have two rates
Australian courts will not enforce a penalty: a charge on breach that is out of proportion to the lender’s legitimate interests. To stay on the right side of that rule, lenders usually write the contract the other way around. The rate in the contract is the higher rate. The borrower is given a concession, the lower rate, for as long as every payment is made on time and no other default occurs. Lose the concession and the higher rate applies. The economic effect is the same as a default rate, and courts have generally accepted the structure.
What triggers it
- Missing a monthly interest payment.
- Not repaying the full balance on the expiry date. This is the most common trigger on short loans with prepaid interest.
- Letting insurance lapse, or not paying rates or land tax on the security.
- Default on a prior mortgage.
- An insolvency event, such as a director appointing an administrator.
- A breach of another term, such as granting further security without consent.
What it costs
| Lower rate | Higher rate | |
|---|---|---|
| Example rate | 1.25% a month | 3.25% a month |
| Monthly interest on $600,000 | $7,500 | $19,500 |
| Three months past expiry | $58,500 in interest, against $22,500 at the lower rate |
These are illustrative figures. The extra $36,000 comes straight out of the equity in the property. Lenders also charge their enforcement costs, such as legal fees and default notices, to the loan.
How to avoid it
- Take a long enough term. An extra two or three months costs far less than one month at the higher rate.
- Work the exit from day one. See what is an exit strategy.
- Ask for an extension early. A documented extension, with a fee, keeps the lower rate. See can a caveat loan be extended.
- Keep insurance, rates and the first mortgage current.
- Refinance before expiry, not after. A new lender can settle faster and cheaper when the old loan is not in default. See refinance a private loan.
If you are already paying it
Get a payout figure with a day-by-day interest amount. Talk to the lender about what they will accept for a prompt payout. Move quickly on a refinance or sale, because every week matters. If you think the rate or the fees are out of proportion, a solicitor can advise whether the penalties doctrine or unfair contract terms law gives you an argument. General information only, not legal advice.
What to check before signing
The higher rate. The grace period, if any. Whether the higher rate applies from the date of default or is backdated. And whether it applies to the whole balance. Put these alongside the headline rate when comparing private loan offers.
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Get matched with a funderFAQ
Is default interest legal?
Generally yes. Courts have upheld the higher and lower rate structure. A default rate that is out of all proportion to the lender's legitimate interests can be challenged as a penalty, but that is a court process with no guaranteed outcome.
Does one late payment trigger it?
Under most contracts, yes, and some apply it for the whole month or until the loan is back in order. Check the wording and any grace period.
Can default interest be negotiated?
Before signing, sometimes. After default, lenders will sometimes waive or reduce it as part of an agreed extension or a prompt payout. Ask.