How Arrears Work

In some instances, arrears, or arrearage, can be used to describe payments in various legal and financial fields, including banking and credit, as well as the investment world. The word may have various meanings depending on the sector and context.

As previously stated, arrears apply to any amount that is past due for accounts such as loans and mortgages after the payment due date. Simply put, it indicates that your payment is past due. Accounts may be in arrears for various reasons, including missed car payments, utility bills, and child support payments.

For instance, if your $500 loan payment is due on January 15 and you miss it, you will be $500 in arrears the next business day. If you default on the regular monthly payments after that, you will be $500 in arrears before making up the payment you skipped.

Similarly, if you paid $300 of the January 15 bill, you would be $200 in arrears as of January 16 before you pay it off and get your account current.

Depending on how you use the word, being in arrears may have a positive or negative connotation. Arrears may refer to payments made at the end of specified duration in certain situations, such as bonds.

Similarly, you can pay mortgage interest in arrears, which means that each monthly payment includes the previous month's principal and interest.

Payment in Arrears

Payment in arrears refers to a payment made of service rendered. It's not the same as paying in advance or paying late. Payments are rendered to salaried workers after the employee has provided the service to the employer.

It refers to a single arrear that isn't late for payment. Postpaid phone service, postpaid water bills, postpaid energy bills, property taxes, and other types of payments in arrears are examples.

Payment in Advance

You make this kind of payment before rendering the service. Leasing, usually charged at the beginning of each month, is an example of a lease in advance. The payment is said to be one month in arrears if a tenant fails to honor the payment at the beginning of the month and makes the payment one month later.

Insurance rates, internet service bills, prepaid phone service, mortgage, prepaid energy bills, and other payments made in advance are examples.

Examples of Arrears

Arrears is also a term used in the banking and credit industries. Annuity payments are one example. An annuity, such as loan repayment, is a set of equivalent payments made at regular intervals.

For example, $250 per month for ten years; if the annuities are due at the end of the contract, such as interest payments, they are considered an ordinary annuity or annuity in arrears.

Interest on certain loans is due in arrears. It means that the interest is due on the loan's maturity date rather than in installments over the life of the loan, as with an annuity payment.

Dividends, often considered arrearage, are dues but unpaid to preferred shareholders. If a company loses a cumulative dividend payment, dividends are said to be in arrears.

It's because preferred shares have fixed dividends regardless of whether the company makes a profit or not. The company must disclose dividends in arrears in the financial statement's footnotes.

Therefore, the company can't pay dividends to common shareholders until it settles its dividends payable account. In the meantime, companies can charge interest on bonds in arrears.

When an issuer pays a $50 coupon payment semi-annually, the interest on the bond must accumulate for six months before making payment to the bondholders.