The account is in arrears if one or more contractually required regular payments have been missed, such as mortgage or rent payments and utility or telephone bills. Similarly, payments made at the end of a period are also considered to be in arrears. In this instance, payment is expected after a service has been rendered or completed, not before.
• Arrears is a financial and legal term that typically refers to an obligation or liability for which payment was not received by the due date.
• Being in arrears may not have a negative connotation, such as when payment is expected after a service has been provided or completed, rather than before.
When payments are due at the end of the period, annuities are known as annuities in arrears (or ordinary annuities).
• Arrearage refers to dividends that are due to preferred shareholders but have not yet been paid.
Understanding About Arrears
In a variety of legal and financial contexts, including the banking and credit industries and the investment world, arrears or arrearage can be used to describe payments. Depending on the industry and the context in which it is used, this term can have a variety of meanings.
As stated previously, arrears typically refers to any amount that is past due for accounts such as loans and mortgages. It simply indicates that your payment is late. Accounts can also be in arrears for automobile payments, utility bills, and child support, or whenever a payment is due and not made.
Depending on the context, being in arrears can have either a positive or negative connotation. In certain instances, such as with bonds, arrears can refer to payments made at the end of a specified period. Likewise, mortgage interest is paid in arrears, meaning that each monthly payment includes both the principal and interest for the previous month.
Example of Arrears
If your $700 loan payment is due on January 15 and you miss the payment, you are $700 in arrears the following business day.
Even if you continue to make payments every month after that, you remain $700 behind until you make up the payment you missed. Likewise, if you paid $400 of that January 15 payment, you are $300 behind as of January 16 until you pay it off and bring your account current.
Depending on the context, being in arrears can have either a positive or negative connotation.
Payment in Advance vs. Payment in Arrears
When two parties reach an agreement in a contract, payment is typically made prior to or after the delivery of a product or service. It is common for rents, leases, prepaid phone bills, insurance premium payments, and Internet service bills to be paid in advance. These types of payments are known as advance payments. When the bill is 30 days past due, for example, the account falls into arrears and the account holder may receive a late notice and/or a penalty.
There are also instances in which bills or obligations become due after a service has been rendered, such as with utility bills, property taxes, and employee salaries. These payments occur at the end of the period and are not considered to be late. However, they fall into arrears if they are not paid by the due date.
Also applicable to payroll accounting are arrears. When payrolls are behind, the previous week's (or other period's) payments are processed and distributed to employees, rather than wages earned during the current period. Instead, current pay would occur as payroll and be processed at the end of each period.
Types of Arrears in Finance
Annuity in Arrears
The term arrears can also be applied to financial situations. An illustration would be annuity payments. An annuity, such as a loan repayment, is a series of equal payments made at regular intervals, for example, $250 per month for ten years. If annuities, such as mortgage payments, are due at the end of the period, they are known as ordinary annuities or annuities in arrears.
Dividend in Arrears
Arrearage also applies to preferred shareholder dividends that are due but have not been paid. Due to the fact that preferred shares have guaranteed dividends irrespective of whether the company makes a profit or not, dividends are said to be arrears if a cumulative dividend payment is missed. The dividends in arrears must be disclosed in the financial statement's footnotes. The company is also prohibited from paying dividends to common shareholders until its dividends payable account is settled.
Interest in Arrears (Bonds)
Some loans have delinquent interest payments. This means that the interest is due at the maturity date of the loan, rather than in installments throughout the life of the loan, as would be the case with an annuity payment. Interest on bonds is typically paid in arrears. When an issuer makes $100 coupon payments semi-annually, bondholders must wait six months for interest to accrue before receiving payment.
Arrears Swap
An arrears swap is an interest rate swap that is similar to a regular swap, except that the floating payment is depending on the interest rate at the end of the reset period, rather than the beginning, and is applied retroactively.
What Kinds of Payments is in Arrears?
Any overdue payment can be considered to be in arrears. Payroll, mortgage, rent, automobile payment, child support, credit card, and taxes are some of the most common types of payments that fall behind.
Does Arrears Mean Delay Payment?
A debt or payment that is still owed after the due date has passed is said to be in arrears. It is equivalent to the payment being past due.
Is Arrears Always Negative?
In certain contexts, such as bond trading, where arrears refers to payments made at the end of a specified period, the answer is no. Mortgage interest is paid in arrears and only carries a negative connotation after the due date has passed.
Why Companies Often Pay in Arrears?
Businesses benefit from paying in arrears because it allows them to have greater cash flow flexibility; instead of having to pay obligations with current cash flows, they can accumulate cash for later payment. This allows the company's accumulating cash to earn interest before being distributed.
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