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2.10.7.2 Pyramiding Late Fees

The “pyramiding” of late charges is one method that creditors use to assess multiple late charges on an account after as little as one late payment. Pyramiding is accomplished by attributing a borrower’s current payments first to outstanding late charges or overdue amount and then second to the installment that is currently due.

For example, if a borrower must make $100 monthly payments on a loan, due on the first of each month, and the borrower makes their January payment of $100 after the grace period has expired, on January 20th, a $5 late fee will be assessed for the late January payment. When the borrower makes a $100 February payment, even if that payment is timely made on February 1st, the first $5 of the payment will be attributed to the January late charge rather than to the February installment. As a result, the borrower will be $5 short in their February payment, and the lender will add another late fee for the February payment. The account will now have a $10 outstanding balance before the March payment comes due, consisting of $5 from the payment shortage and $5 from the new late fee. The process will repeat, with a late fee being added in March and every subsequent month, even if all these payments are made on time.

The pyramiding of late charges presents a hidden-interest problem, in that the monthly addition of late charges to a debtor’s account, when only one or two payments may actually have been late, constitutes a de facto increase in the interest rate.207 However, proving hidden interest through pyramiding may not be an easy case in many states, at least in the absence of a statute prohibiting the practice.208

A Federal Trade Commission (FTC) rule prohibits this type of late charge pyramiding. The FTC Credit Practices Rule declares it an “unfair act or practice” for a creditor to impose a late charge “when the only delinquency is attributable to late fee(s) or delinquency charge(s) assessed on an earlier installment.209 Regulation Z, which implements the Truth in Lending Act, also prohibits the pyramiding of late charges for mortgages secured by a consumer’s principal dwelling.210 As with the FTC rule, Regulation Z prohibits a servicer from imposing any late fee or delinquency charge if the charge is solely attributable to the failure of the consumer to pay a late fee or delinquency fee on an earlier payment. Fannie Mae and Freddie Mac Servicing Guides effectively disallow late-fee pyramiding. Freddie Mac does not permit the collection of a late charge from a regular monthly payment or from a payment made to cure a delinquency.211 The Freddie Mac Servicing Guide also states that the servicer may not cause the mortgage to become delinquent or place it in foreclosure because of an unpaid late charge. Fannie Mae’s Servicing Guide states that servicers must accept and apply periodic payments even though the amount excludes any applicable late charges.212

Another form of pyramiding occurs when the borrower misses a single payment but makes subsequent regular payments on time. In such cases, most servicers treat each subsequent payment as one month late and assess late charges every month until the account is current. Neither the FTC rule nor Regulation X restricts this type of pyramiding, despite its inherent unfairness. The practice is prohibited in states that adopted the 1974 version of the Uniform Consumer Credit Code.213 Other state laws may limit this form of pyramiding.214 In addition, imposing a late charge under these circumstances may violate the payment application provision found in the security instrument.215

Footnotes

  • 207 {202} See National Consumer Law Center, Consumer Credit Regulation §§ 4.8.2, 4.8.3 (3d ed. 2020), updated at www.nclc.org/library.

  • 208 {203} See, e.g., 24 C.F.R. § 203.25 (FHA loans); 38 C.F.R. § 36.4212 (VA loans); U.C.C.C. § 2.502(3) (1974).

  • 209 {204} 16 C.F.R. § 444.4.

  • 210 {205} See § 4.2.4.4, infra (discussing Regulation Z’s no-pyramiding rule).

  • 211 {206} Freddie Mac Single-Family Seller/Servicer Guide § 9102.2 (Mar. 2, 2016), available at www.freddiemac.com.

  • 212 {207} Fannie Mae Single-Family Servicing Guide, at C-1.1-02 Processing Payment Shortages or Funds Received When a Mortgage Loan Modification Is Pending (Dec. 11, 2019), available at fanniemae.com. See also Fannie Mae Single-Family Servicing Guide, at A2-3-04 Late Charges As Compensation (Dec. 11, 2019), available at fanniemae.com (“The servicer may collect any late charges that are provided for in the mortgage instrument as long as they are consistent with federal and state laws.”).

    Note that previously Fannie Mae’s guidelines permitted servicers to “hold as unapplied a payment that is only missing a late fee due and use a portion of the subsequent payment to make up the shortage.” Fannie Mae Single-Family Servicing Guide, at pt. III General Servicing Functions, ch. 1 Mortgage Payments, ch. 101.03 Payment Shortages (Jan. 31, 2003), available at fanniemae.com.

  • 213 {208} U.C.C.C. § 2.5.02 (1974). See National Consumer Law Center, Consumer Credit Regulation § 2.3.10 (3d ed. 2020), updated at www.nclc.org/library (discussing the UCCC).

  • 214 {209} See, e.g., Ky. Rev. Stat. Ann. § 367.320 (West) (applicable to high-cost loans only); N.C. Gen. Stat. § 24-10.1; W. Va. Code § 46A-3-112.

  • 215 {210} See § 2.4, supra (discussing payment application provisions).