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What are Arrears?

definition

Arrears refers to payments you owe after you’ve already received a good or service, whether that’s due to a contractual agreement or an overdue payment.

🤔 Understanding arrears

Arrears usually refers to an overdue payment. If you’ve missed one or more payments on your mortgage, credit card bill, child support, or anything else, that amount is in arrears. Payment in arrears doesn’t always imply a negative situation — It also describes an arrangement in which you pay for goods and services at the end of a period (like a mortgage or utility bill). Payment in advance, on the other hand, involves handing over funds up front.

example

Imagine Nicole rents an apartment for $1,000 a month. In September, Nicole doesn’t pay her rent when it’s due on the first of the month. On Oct. 1, Nicole resumes paying her rent. She still has a payment in arrears, because she hasn’t paid the $1,000 she owes for September’s rent.

Takeaway

Having a payment in arrears is kind of like being late for work…

Even if you finally show up and work until the end of your shift, eventually, you’re going to have to make up the hours you missed to get your full 40 hours in. Likewise, if you have a payment in arrears, even if you’ve paid on time for subsequent months, you still have to make up that missed payment.

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What are the different types of arrears?
What is the difference between payment in advance and payment in arrears?
How do arrears relate to investing?
How do arrears relate to mortgages?
What are child support arrears?

What are the different types of arrears?

Arrears refers to payments made after a good or service was provided. While this often has a negative connotation, other types of arrears are not a bad thing:

Overdue Payments

Arrears often refers to overdue payments. People may miss payments on things like loans, credit card bills, or child support, either because they couldn’t afford to pay or forgot to pay.

Let’s say you forgot to pay your cell phone bill last month. You now have a payment in arrears. If the next month rolls around, and you pay your cell phone bill on time, you’ve still got a problem — You haven’t paid your cell phone provider for the missed payment. This amount remains in arrears until you pay the bill for the month you missed.

Paying After the Fact

There are plenty of times when a payment in arrears is not a problem — Sometimes, it’s part of a contract.

Parties often agree that payment will be due after goods and services are provided. In this scenario, someone is still paying a bill by the due date — It’s just that the due date comes after the exchange of the goods or services.

Think of payments in arrears in terms of eating in a restaurant. In most restaurants, the waiter takes your order and brings you your food and drinks. At the end of the meal, you’ve consumed the goods the restaurant provided, but you haven’t paid for them yet. In other words, you have a payment in arrears. It’s okay, though — The restaurant has agreed that you don’t have to pay for the food until after you’ve eaten it. So while you have a payment in arrears, you don’t have a late payment.

What is the difference between payment in advance and payment in arrears?

When one party is providing a good or service to another, they typically agree on when payment will occur. The contract usually includes one of two options: payment in advance or payment in arrears.

Payment in Advance

Many contracts expect you to pay ahead of time. For example, your landlord wants you to pay rent at the beginning of the month to continue living in a property that month. Other common examples of payment in advance include internet service, prepaid phones, and insurance.

Payment in Arrears

Other contracts stipulate payment in arrears — meaning you pay after receiving goods and services. When you get a paycheck, you’re receiving payment in arrears, since the compensation is for work performed in the past.

Payment in arrears is also standard with utility bills and property taxes in some states. These are payments in arrears even if they’re not late, because the parties agreed that the bill would be paid after they exchanged goods or services.

You can have a late payment whether a contract requires payment in advance or payment in arrears. Regardless of when you have to pay the bill, you have to pay it by the due date. If you don’t, that payment is in arrears.

How do arrears relate to investing?

Arrears can also come into play in investing. Publicly traded companies pay dividends to their stockholders. Holders of preferred stock generally receive guaranteed dividends regardless of the company’s profits. If a company is late in paying dividends to preferred stockholders, those payments are in arrears, and it must eventually catch up. Having dividend payments in arrears can be damaging to a company’s reputation and finances. A company in this situation must disclose so on its financial statement, which may scare off investors.

Arrears also come into play when investing in bonds. Bond interest payments are usually paid in arrears, meaning bondholders are paid after the interest accrues, usually every six months.

How do arrears relate to mortgages?

Renters usually pay in advance — They pay rent at the beginning of the month they plan to live in a property. Mortgage payments work differently: Home loans usually require payment in arrears, meaning you are making your mortgage payment for the previous month.

One reason mortgage payments work differently than rent is that they include interest, which you can’t pay until it has accrued. So when you pay your mortgage bill at the beginning of February, you are paying the interest that accrued in January.

While mortgage payments are paid in arrears in general, it’s also possible to have a mortgage payment in arrears because it’s late. It can be a good idea to make up overdue payments as soon as possible, since not doing so can lead to late fees or even foreclosure. If you can’t afford to catch up, you may want to communicate with your mortgage lender to see if you can come up with a payment plan.

If your payments were late because your mortgage payment is higher than you can afford, you may want to try lowering your payment by refinancing your mortgage or extending the term over a longer period. You may also be able to add these payments in arrears to the mortgage as capitalizing arrears, meaning you repay the late payments over the life of the mortgage.

If you have mortgage payments in arrears and can’t catch up, you might be able to avoid foreclosure by selling your home (a short sale may be an option if you owe more than the home is currently worth and your lender approves). Once the foreclosure process begins, you might not be able to sell. And remember, you’ll still have to pay the entire amount in arrears after you sell the house, including the late payments, unless you do a short sale.

What are child support arrears?

Child support arrears are past-due child support payments. In most cases, the noncustodial parent (the parent without primary custody) makes these payments to the custodial parent (the parent with primary custody).

If you owe child support and haven’t kept up with payments, state agencies may step in to help collect them. This might be in the form of income or wage garnishments (meaning the government takes money out of your paycheck), tax withholding (meaning money is taken out of your tax refund), having your driver’s license revoked, or contempt of court (an offense that refers to defying court orders and could result in fines or jail time). A court might also add interest to child support arrears, meaning the amount owed would continue to increase.

There could also be situations where you owe child support arrears to the state rather than to the custodial parent, such as if the primary parent received public assistance to care for their child.

Child support arrears don’t disappear when the child in question becomes an adult. No matter how old the child is today, all arrears have to be paid back eventually.

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