Summary

  • The statutory default is simple interest. The 1998 Act gives you simple interest at 8% above the Bank of England base rate. Relying on the Act alone, you cannot charge interest on the interest.
  • Compounding interest is a contractual choice. You can charge interest on the interest only where your own terms of business provide for it, as a “substantial contractual remedy” for late payment.
  • How to compound late fee interest works. Post each month’s interest as an invoice, let it join the outstanding balance, and calculate the next month’s interest on that new total.
  • Multiple late fee invoices on the ledger. Each month’s charge sits as its own posted invoice, so the customer sees the balance and the cost of delay rising every month.
  • How to automate this in Trove. Set interest to accrue against the balance, post each period’s charge as its own draft invoice, and the next period is calculated on the updated balance, so it compounds month by month.

When you can charge compounding late fee interest in the UK

Statutory interest under the Late Payment of Commercial Debts (Interest) Act 1998 is simple interest, fixed at 8% above the Bank of England base rate and calculated on the debt itself. It doesn’t compound. If you’re relying on the statutory right alone, each month’s interest is worked out on the original invoice, and that’s as far as it goes. Our guide to whether late payment charges are legal in the UK covers the statutory position in full.

However, the Act does let you set your own terms instead, provided they amount to a “substantial contractual remedy” for late payment. That’s where compounding lives. If your contract or terms of business say interest is charged on the outstanding balance, including interest already added, then you can compound. If they don’t, you can’t, and adding interest to the interest wouldn’t be enforceable.

This is how the Act typically works in practice but isn’t legal advice. It’s worth checking your engagement letter or terms of business, or asking your solicitor, before you rely on it with a customer.

Why a business would want to compound late fee interest

For most overdue invoices, simple interest is plenty and many businesses waive it entirely once they’re paid. Compounding tends to come up for one specific situation: a persistent debtor who’s already ignored the ordinary reminders and is sitting on a balance for months.

For a customer who’s been unresponsive, a growing, compounding balance is a sharper prompt and can lead to them taking faster action.

How monthly compounding interest works for overdue invoices

The mechanics are straightforward.

How compounding late payment interest worksA bar for each month from 1 January to 1 April. Each bar shows the original debt at the base with a slice of interest added on top each month. Because each month’s interest is charged on the whole balance below it, the base grows and the added interest gets larger each month, which is compounding.How compounding late payment interest worksThe interest is charged on a bigger balance each monthOriginal debtNew debtInterest added that monthDebtDebtDebtDebt1 JanDebt due, unpaid1 Feb+ Jan interest1 Mar+ Feb interest1 Apr+ Mar interestEach month’s interest is charged on the whole balance below, so the base keeps growing. That’s compounding.Illustrative, not to scale

Say an invoice falls due on 1 January and stays unpaid. On 1 February you raise a late fee interest invoice for January, calculated on the original debt. That interest now forms part of the customer’s total overdue balance.

On 1 March you raise interest for February, but this time it’s calculated on the original debt plus January’s interest. On 1 April, on the debt plus January’s and February’s interest. Each month the base the interest is charged on is a little larger, which is why it now compounds.

The difference from ordinary simple interest is in what you calculate on. Simple interest is always based on the original debt only. Compound interest is calculated on the running balance, late fee interest included.

Calculating compounding late fee interest in Trove

Trove takes the manual work off your hands. Here are the steps to automatically calculate compounding late fee interest in Trove:

  1. Set up your late fee policy. Set your interest amount and select ‘compounding’ vs ‘simple’.
  2. Automatically enrol invoices. You can automatically enrol invoices when they hit a certain number of days overdue. Alternatively, keep it manual and just select the ones to apply this to.
  3. Trove calculates monthly. Each month Trove will now calculate the late fee interest due and create a new invoice for the interest. This then becomes part of the customer’s overdue balance which means next month’s invoice will be a bit higher.

Getting started

Charging interest on the interest is worth setting up only for the handful of accounts where it’s justified and your terms allow it. For everyone else, simple interest is usually the right tool, and the complete guide to UK late payment fees covers what you’re entitled to charge before you get into compounding.

Automate compounding late fee interest

Set your policy once and Trove raises each month's interest invoice on the updated balance, so it compounds without you doing the maths.

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