Grace Period: What Is It and How Does It Work?

What is Grace Period?

A grace period is the time after the due date of an obligation, typically a loan or insurance contract, during which payment can still be made without penalty. It offers temporary relief to the payee, since the late payment does not negatively affect the payee’s credit score.

Grace periods typically range from a few days to 2 weeks, but can differ based on the type of contract, credit history of the payee, and relationship between parties.

How does a grace period work?

A grace period gives a borrower or insurance customer time to make a delayed payment even beyond the due date without late fees, penalties or cancellation of the contract or loan.

This period is decided upon between the parties well before the transaction is initiated. Payments made during the grace period do not negatively impact an individual or business’s credit score.

Grace periods are only typically found in insurance contracts, mortgage loans; credit cards and overdraft facilities do not offer a grace period. The details of the grace period depend on the type of loan, the specifics of the loan contract and the flexibility offered by the bank or insurer.

For example, some banks add compound interest during the grace period, while others don’t charge any interest at all. This is why it is important to read all contracts, terms and conditions carefully for anything related to grace period.
Credit cards operate with a similar concept – a credit card grace period is the time between the end of the billing cycle and the payment due date. During this time, cardholders do not incur any interest or late fees.

Example of Grace Period

Let’s take a look at this example:

Ravi has a mortgage with a due date of the 10th of every month and as per the agreement it has provided  7 day grace period.

This means that the customer can pay the amount as late as the 17th of the month without being charged with any penalties. 

This is an example of a grace period in the case of loans.

Ravi’s credit card payment due date was on the 12th of every month and let’s say he has a 15-day grace period. Ravi had missed the due date, so in that case, Ravi can make the payment by the 27th of that month without any penalty charges.

In the case of credit card repayment, credit card issuers provide a grace period beyond the due date during which any kind of penalty will not be charged.

Ravi’s insurance due date is on the 15th of the month and as per the agreement let’s say he has a grace period of 10 days. Therefore, Ravi can make the insurance payment by the 25th of the month without any penalty charges.

The insurance grace period enables protection of the policyholders from any loss of coverage especially when they delay the payment of premiums.

This is again dependent on the nature and type of Insurance.

Related Read: How to Make Credit Card Payments Through NEFT?

Grace Period vs Deferment

Although Grace Period and Deferment might sound similar there lies certain differences between the two.

Let’s have a look.

Grace Period Impact on Credit

The biggest advantage offered by a grace period is the financial flexibility. Paying off the balance within the grace period reduces the amount of outstanding credit reported to credit bureaus. A lower credit utilization ratio (the percentage of available credit being used) is favorable for credit scores.

Paying off your credit card balance within the grace period ensures you meet payment deadlines, which builds a strong payment history. Payment history is the most significant factor in determining your credit score.

Paying the balance in full within the grace period keeps your credit utilization ratio low. A lower ratio (below 30%) reflects responsible credit usage and boosts your score.

Penalties for Missing Payment

Missing a credit card payment beyond the grace period can lead to several penalties that affect your finances and credit health.

Late payment fees

Credit card issuers typically charge a late payment fee for missing the due date. When accumulated, this can cause financial stress.

Loss of Grace Period

Missing a payment often results in losing the grace period. This means future purchases will accrue interest immediately, adding to your financial burden.

Impact on Credit Score

Late payments are reported to credit bureaus if they are 30 days past due, potentially lowering your credit score. A single late payment can remain on your credit report for up to seven years, though its impact diminishes over time with consistent on-time payments.

Restricted Account Usage

Repeated missed payments may result in the card issuer restricting your account. In extreme cases, your account could be closed, limiting access to credit and further impacting your credit score.

Advantages of Grace Period

Let’s have a look at the advantages of the grace period:

1. Longer payment time

Since the borrowers can still make the payment beyond the due date without any penalty charges, this allows them a longer time period to make the payment. Hence this will also enable them to avoid bad debt. Any transaction that occurs during the period will be added to the bill for the next month.

2. No Interest

Any transaction that occurs during the grace period will not be subject to any interest charges and no penalty charges will be levied.

3. Avoid blacklisting

Making a payment within the grace period will not show a black mark on a borrower’s credit report. If the payment is made during the period, it will not be reported to the credit bureaus and therefore will not have an effect on the borrower’s credit score.

This period can be extremely helpful for borrowers who might have missed their due date or are currently facing a financial crisis. It is always advised to be aware of the terms and penalty structures provided by the service providers.

Today banking has significantly evolved.

The evolution of the fintech space has had a significant impact on businesses today.

Read more: What is Fintech? Meaning and Evolution

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