How to Set Late Fees on Invoices

What is a late fee?

A late fee is a charge that applies to a client’s invoice if they fail to make a payment on time. It’s usually either a set amount, like $15, or interest-based and is charged after the invoice due date has passed (depending on your payment terms). 

For example, if you allow clients to make payments within 14 days of receiving an original invoice, you wouldn’t charge a late fee until the 15th day at the earliest. 

Most late fees are charged 1-30 days after a due date has passed, and the amount you charge varies based on your business, clients, and the laws in your state.

Is it legal to charge late fees?

Yes, it’s legal to charge late fees on overdue invoices as long as you outline the terms in your contract with a client. 

You have to provide customers with a copy of your late payment policy prior to beginning a job, and they must acknowledge it with a digital or in-person signature for it to be valid. 

Pro Tip: Different states regulate the amount of interest you can charge. Check your state’s usury laws to ensure you don’t exceed the limit.

How to calculate late fees on invoices

How much you charge for late payments depends on whether you decide to charge a flat rate or late payment interest. The four most common ways to charge late fees are interest, compound interest, flat rate, and hybrid. 

1. How to charge interest on overdue invoices

A standard late fee for interest rates is 1-2%. Because interest rates penalize customers based on the value of the job, they’re considered the fairest way to charge late fees. 

They work by being applied each day, week, or month when an invoice is overdue. For example, on a $500 invoice with a monthly interest rate of 2%, the client would owe you $502.50 after one week and $510 after the first month. 

The formula for calculating interest is as follows: 

[invoice total] x [interest rate] = interest charge

2. Calculating compound interest

Compound interest works similarly to regular interest, but instead of being calculated based on the amount of the invoice, it’s calculated based on the total amount due—including previously applied interest charges. 

For example, on a $500 invoice with a 2% interest rate, an additional 2% (or $0.20) would be charged on the total due each day. After 30 days, the balance would be $510. At 31 days, the balance would be $510.20. 

To calculate compound interest, you would use the same formula as above, but change the total due to include previous interest charges. 

The formula to calculate compound interest looks like this: 

[invoice total] x [interest rate] x [number of days / 365] = interest charge

3. Charge a flat rate

With flat rates, customers are charged the same fixed fee each week or month until payment is made in full. Flat rate fees are easy to calculate but should be based on the value of the invoice instead of one single rate for any past-due payments. 

For example, you may charge $10 for invoices under $500 and $25 for invoices over $1000.  

4. Take a hybrid approach

Hybrid late fees are when you combine a flat fee with an interest rate. 

For example, if you have an initial late payment charge of $15 on every invoice, the interest would compound at 2% after that.

How should I charge late fees?

Each method for charging late fees has pros and cons. While flat rates are straightforward and easy to calculate, they may not be fair to every client. 

Although charging interest is a fair choice, you may not have time to calculate individual interest fees for each client every month. 

Ask yourself the following questions to help determine which late fee strategy you prefer:

• How often do clients miss payments? The more frequently you have to deal with outstanding invoices, the more need there is for a comprehensive late fee policy. 
• What’s the value of my average invoice? If it varies by a lot, interest fees may be the best way to keep things fair for every client. If it doesn’t, a standard late fee could suffice. 
• Do I have time time to calculate compound interest or hybrid fees for each late invoice?
• What’s fair to both my service business and my clients? 
• What are the laws in my state surrounding interest rates and late fees?

Pro Tip: If you still aren’t sure how to charge late fees, take a look at what your competitors do. This will give you an idea of what’s standard in your industry. If that doesn’t work, try asking other service business owners in your industry in a forum or group like the Jobber Entrepreneurship Group.

How to create a late fee policy

Late fee policies aren’t just legally required. They’re beneficial to you and your customers because they clarify your credit terms and outline important information like your late fees, when they take effect, and how they’re charged (for example, by credit card). 

The first step in creating a clear and enforceable payment policy is to figure out: 

• Whether you’ll charge a flat rate, interest, or both
• How much you’ll charge
• When your policy comes into effect (will you charge a late fee immediately after the deadline passes or offer a grace period?)
• How often you plan to send payment reminders (once a day, every three days, etc.)
• If there are any exceptions to your policy (for example, in the event of a personal tragedy or unforeseen circumstances)

Once you have that information, use this template to word your late payment fee policy for your contracts, quotes, and invoices.

How to tell customers about your late payment policy

After you set the parameters for your late fee policy, it’s time to tell your clients about it. 

The best way to do this is to send out an email announcing the change to ensure all your existing customers get some advance notice. 

If you need help with late fee payment wording, use this payment policy template to draft your notice:

What to do when late payment fees don’t work

If your customer still won’t pay after you’ve put a late fee policy in place and applied it to their invoices, you have three options: 

1. Send a reminder. Clients don’t always miss payments on purpose. Often, it’s because they missed the invoice or lost track of the email. Send an overdue payment reminder once the invoice due date passes to make sure they’re aware a payment’s due. 
2. Offer them a payment plan. If a customer is struggling to pay you, offering customer financing will give them some relief and you’ll get paid in installments—which is better than not at all. Plus, they’ll appreciate your flexibility and understanding. 
3. Hire a collection agency. After 60 days, you can hire a debt collector to chase down the customer for you. They’ll either charge you a flat fee or a percentage of the debt in exchange for their services. 
4. Pursue legal action. After you send out your final payment reminder email, it may be time to hire an attorney, especially if the nonpayment seriously impacted your ability to do business. A lawyer can reach out on your behalf or help you if you choose to take the dispute to small claims court.

But your best strategy is to prevent late payments from happening in the first place. To reduce your chances of having to deal with overdue invoices in the future, use these tips: 

• Create professional invoices with clear terms
• Offer early payment discounts
• Send invoices immediately after you’ve sold your products or services
• Track the status of all your invoices
• Send automated payment reminder emails and texts
• Provide invoice financing options to customers who need help paying
• Accept a variety of payment options, including credit card, ACH payments, and e-transfers
• Set automatic payments for recurring work

By using software to build and employ a solid strategy, you’ll make it easy for customers to make a payment deadline. And, when they don’t, it’ll be much easier for you to clear up outstanding invoices because you’ll have a clear outline to follow.