What is default interest?

Contracts express default interest in a few common ways: a fixed margin above a base rate such as the RBA cash rate, a fixed annual percentage on overdue balances, or a daily rate derived from an annual percentage. A well-drafted clause also states the day-count convention (365/365, actual/365 or actual/360), whether interest compounds, and whether it is charged on principal only or on principal plus interest already accrued.

The usual method is simple interest: overdue amount multiplied by the annual default rate (as a decimal) multiplied by days overdue divided by 365. Where a daily rate is specified, multiply the overdue amount by the daily rate and the number of days. Compounding applies only where the contract explicitly permits it, and a 360-day basis produces a slightly higher daily rate, so always check the clause. For judgment debts, the court's published rate and calculation rules apply.

Lenders and creditors charge default interest to compensate for the loss of use of funds, to deter late payment and reduce credit risk, to recover collection and legal costs, and to protect margins on unsecured or higher-risk credit. You will meet it in personal loan contracts, commercial supply invoices, equipment finance, leases and judgment debts.

Common triggers are a repayment missed by its due date, a breach of a covenant such as failing to keep the asset insured or to provide financial statements, an event of default including insolvency or cross-default clauses, and a court judgment for unpaid amounts. Once a debt is reduced to judgment, statutory post-judgment interest at the court's published rate typically applies from the judgment date instead of, or alongside, the contractual rate. Exactly how and when default interest applies depends on the contract wording and the law that governs it.

Parties are free to agree a rate, but a court may not enforce a clause that is out of all proportion to the lender's legitimate interest in being repaid on time, or that is unconscionable. Standard form small business contracts can be challenged under the unfair contract terms rules, and regulated consumer credit is also covered by the National Credit Code. Regulated credit providers must disclose default rates and calculation methods in the contract. Some statutes and cases limit the recovery of interest on interest. Legal and collection fees are recoverable only where agreed and reasonable.

If default interest looks excessive or wrong, the practical steps are to identify the exact clause, day-count basis and compounding provision, ask the lender for an itemised calculation of principal, days and rate, dispute it in writing, and propose a payment plan or settlement. Unresolved complaints can go to the lender's internal dispute resolution and then an external dispute resolution scheme, and a suspected penalty clause is a matter for legal advice.