Grace Period

Updated on April 12, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Grace Period Meaning

Grace period is extra days given after the due date to undertake an unfulfilled obligation without penalties. They are a common instance in the financial world and are usually offered to clients who apply for credit cards, student loans, insurance, or mortgage to attract more customers.

Grace Period

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However, it is necessary for the borrower to carefully understand the terms before entering into the contract or taking the loan. But such a facility is very useful in case of unpredictable contingencies due to which the borrower cannot pay up within the due date. It differs depending on the type of loan.

Key Takeaways

  • A grace period is the extra number of days given after the due date to undertake the unfulfilled obligation without suffering any extra charges.
  • It comes with different features. As such, debtors should understand their terms before taking mortgages, student loans, credit cards, and other credit lines. For example, it is offered for two weeks to a month in the case of credit cards.
  • They come in handy when an unforeseen occurrence hinders the timely payment.

Grace  Period Explained

Grace period is the time limit or the number of extra days offered by the lender to the borrower after the crossing the payment date. This gives some extra time to the borrower to arrange for funds to make the payment.

Financial institutions offer credit in any form except the debtor to pay the agreed sum based on the arrangement between the creditor and the debtor. In some cases, the creditor does not penalize the debtorDebtorA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read more for not making the payment by the deadline. They can then make the price later without extra charges using the mortgage grace period.

The duration in which the debtor can enjoy this privilege depends on the agreement between the financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more and the borrower. This gives the debtor more time to come up with the funds and make the payment without incurring an additional charge till the grace period has not lapsed. Upon the lapse, the owed amount is subjected to penalties such as interest and cumulative fees.

The mortgage grace period are sometimes offered as an introductory perk to new clients who sign up for a financial service. However, since different grace periods have different features, debtors should understand their terms before taking mortgages, credit cards, and other credit lines. Important ones include:

  1. Ramifications of not paying the debt when it lapses.
  2. The factors that could lead to its cancellation.
  3. How making partial payments will affect it.
  4. Any hidden costs associated with it.

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Types

#1 – Mortgage

Mortgage products usually require payments to be made on specific dates. If the whole amount is not paid, the borrower usually has to incur a penalty. Many firms provide a grace period provision of several days to protect them from this. For instance, a two-week grace period gives the borrower the flexibility to make the payment up to two weeks after the due date without incurring any penalties.

The late payment penalties start accruing on the outstanding amount when it lapses. Customers can benefit from such a facility, particularly in tough economic times. It gives them extra time to come up with the payment without ruining their credit scores.

#2 – Insurance

Insurance is important in many facets of life and can come in many forms. For example, car insurance, life insurance and assurance, professional indemnity insurance, and others grant peace of mind to an individual.

Paying insurance premiums on time ensures that the insured has the confidence to know that they would not have trouble finding the necessary money if something goes wrong. However, insurance companies offer a grace period provision to clients if they fail to pay the premium. Normally, it covers the number of days the policy gets inactive upon a failure to make the premium payment.

#3 – Credit Cards

Credit cards have become popular, and this popularity only increases with time. However, when one uses a credit card, they are typically expected to make the payments at the end of the month. Therefore, having an allowance past the expected payment date serves as a cushion for irregularly receiving salaries or wages.

Credit cards usually offer grace periods of two weeks or even a month. In addition, some credit card companies can offer permanent facilities where the customer is allowed extra days (such as a month) to make the payment. When the grace extension lapses, the owed amount is subjected to penalties such as interest and cumulative fees.

#4 – Student’s Loan

Many studies have pointed time and again that many people owe student loans. Moreover, they represent many of all individual debt types in the United States and other countries.

Normally, the federal student loan offers a grace period credit of six months after graduating or discontinuing education. For private loans, the period varies as per the terms of the loan.

Example

Let us assume Ted has rented out his property to Jack at a monthly payment of $1000. As per the rent agreement, Jack is suppose to pay the rent within the 5th of each month. However, being an old friend, Ted has allowed Jack a grace period credit of 5 more days. That means, Jack actually gets 5 more days to arrange for the rent amount and can pay Ted within 10th of each month. This is very beneficial for Jack since he gets extra time and his cash outflow is delayed. But for Ted it is a loss because he will lose the investment return on that money for 5 days, Moreover, the arrangement encourages Jack to take advantage of the dalay which is a loss to Ted.

Benefits

Limitations

Let us look at some of the limitations of this arrangement.

  • Since it gives the borrower some extra time to meet the payment obligation, they may not even try to clear off the amount within the due date.
  • It encourages a negative habit among borowers since they tend to not take the payment process within due date seriously because of the grace period loan.
  • It leads to blocking of funds of the lender for a longer time since the payment date is extended and a delay in recovering the receivables.

Frequently Asked Questions (FAQs)

What is a three-day grace period?

The only purpose of a 3-Day Notice to Pay Rent or Quit is to inform a tenant that they are in breach of their lease because they have not paid their rent and have three days to make things right or leave.

How does grace period work?

A grace period is known as the time between the conclusion of a billing cycle and the day your payment is due. Individuals won’t be charged interest if they pay off the debt in full by the deadline.

Why is there no grace period?

The phrase “grace period” only applies when you can avoid paying interest using a credit card. Therefore, there typically isn’t a “grace period” for your payment.
Repetitive Sentences.

This has been a guide to the Grace Period and its meaning. We explain it with examples, its various types, benefits and limitations. You can learn more from the following articles –