Late fees – what’s better, percentage or flat amount?

Which is the better method of assessing a late payment penalty – a flat amount or a percentage of the past due amount?

Purpose of a late fee

Charging a late fee serves two purposes – to compensate the utility for the loss of operating cash and potential interest income because your customer didn’t pay on time and, secondly, to serve as a punitive measure (which is why some utilities call the late fee a penalty) to entice your customer to pay on time.

Flat amount late fees

A flat amount is the most straightforward and easiest way to charge late fees. It’s easy for your customers to remember, if they don’t pay their bill on time, to add $5 when they do pay.

However, flat amount late fees disproportionately impact your customers with low bills. A senior citizen living alone who receives a minimum bill every month pays the same late penalty as a large industrial user.

Percentage late fees

Charging a late fee as a percentage of the unpaid balance is a more equitable approach, ensuring that customers with lower bills are assessed a lower penalty. However, if the late fee is too low, it may not serve the purpose of motivating your customers to pay on time.

Hybrid method

Back to the original question – which is better, flat amount or percentage? What if the answer to that question is “neither”?

The most creative solution to the flat amount vs. percentage dilemma is a hybrid of the two options. In this case the utility charges a percentage with a minimum amount, for example 10% with a minimum of $5.

Many times, this is expressed as “10% of the balance due or $5, whichever is greater” or “$5 on balances of $50 or less, 10% on balances of more than $50”.

The advantage of the hybrid method is it maintains the punitive aspect of the late penalty for customers with low bills while ensuring that customers with larger bills pay a larger late fee.