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My mom loaned a 'friend' some money a few years ago, which was supposed to be paid monthly. Since then the friend has been paying sporadically and they are now in a disagreement over what the interest for late payments was actually supposed to be applied to. The promissory note they signed says:

"If the undersigned misses a payment then interest will accrue at a rate of 3% per month, with subsequent payments paying the arrears before being applied to the current month's payment."

We are located in BC, Canada. Does anyone know how this should be read?

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    I'm not a lawyer, but I think it means if you're paying $100 a month, and you're 2 months behind, you owe 6% of the total in addition to that $200. And that if you hand over $200, it will be applied to the arrears (the two missed payments) meaning you still owe the 6% and now you've missed the current month's payment.
    – Kate Gregory
    Commented Jul 7, 2015 at 21:02
  • I'm not a lawyer, but social agreements are presumed not to be legally enforceable contracts - does the "promissory note" contain words to the effect that "this is intended to be a legally binding agreement"?
    – Dale M
    Commented Jul 9, 2015 at 6:28
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    Chances are, she will lose a friend and the money.
    – JTP - Apologise to Monica ♦
    Commented Aug 25, 2015 at 21:06
  • @DaleM a signed promissory note is in no way shape or form a "social agreement".
    – RonJohn
    Commented Jan 1, 2021 at 22:41

2 Answers 2

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Accrued interest generally means "interest that is earned but not received" (http://www.businessdictionary.com/definition/accrued-interest.html). This is the interest that is added on top of the amount that was originally agreed upon. Because your friend missed some months, she will have gained 3% interest on top of the original loan amount for every month that she didn't pay. The interest even applies to the increased loan amount, so it will increase exponentially for every month that she does not make a payment. For example, if the loan amount was for $1,000 and she missed the payment the first month, the 3% accrued interest will raise that loan amount to $1030. If she misses the second month, then the loan amount will become $1060.90 and so on. This means that it will take her more months to pay the loan in its entirety.

"Arrears" are the overdue payments that she had not made (http://www.investopedia.com/terms/a/arrears.asp). So the sentence "with susbsequent payments paying the arrears before being applied to the current month's payment" means that she must pay the overdue debt from the previous months first before she can even make the payment for the current month.

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The original note should have had a a clear start and expiration date included with in it (the term). If it did then the term has likely expired by now (since you said it had been years) and you should issue an amendment to the note that clarifies the new term and also clarifies the interest rate terms. If the original note did not have an expiration date then that would be unusual and your mom should work with her friend to execute a new note with clear start and expiration dates and that also clarifies the payment and interest terms. From my experience it is best to include a specific payment schedule within the note as well as very specific and clear terms around how interest will be handled in the event of a missed payment, late payment, or inability to pay the note off in full at expiration. There are many good examples available online to help you craft the appropriate verbiage for your specific needs: http://tinyurl.com/note-examples

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