Default Rate

Default Rate — most promissory notes include a provision for a default rate, which is a higher interest rate that kicks in after the borrower fails to meet their payment obligations. This rate is designed to compensate the lender for the increased risk and administrative burden of managing a delinquent loan. Default rates can be several percentage points above the original contract rate.

Note investors should carefully review the default rate language in any note they are considering for purchase. While a high default rate increases the theoretical amount owed, enforceability varies by state — some jurisdictions limit or invalidate default rates they consider excessive. Understanding whether the default rate is collectible affects how an investor models potential recovery on a non-performing note and can influence the price they are willing to pay.