Contractors can charge interest on late payments when the written contract authorizes it or a prompt payment statute provides it, and only up to the maximum rate allowed by the state’s usury law. A verbal understanding won’t hold up, and you can’t decide after an invoice goes unpaid that you’d like to start adding interest the client never agreed to. The practical answer depends on three things: what your contract says, what state the project is in, and whether you submitted a proper invoice to start the clock.
What the Contract Needs to Say
The strongest basis for charging interest is a signed contract that spells it out. Courts look for specificity. A vague reference to “applicable interest” or unspecified “late charges” invites disputes and may not survive a challenge.
A workable clause covers four points:
- The rate itself, often stated as a monthly percentage. 1.5% per month, for example, works out to 18% annually.
- The grace period before interest starts accruing, such as 30 days from the invoice date.
- Whether the interest is simple or compound.
- Whether the client is also responsible for collection costs or attorney fees if you have to chase the money.
Leave any of these ambiguous and the other side has room to argue. Without a contract clause at all, your ability to charge interest shrinks sharply. A court is unlikely to enforce a charge the client had no notice of before the debt arose.
Late Fees and Interest Are Not the Same Thing
Contractors sometimes use “late fee” and “interest” interchangeably, but courts draw a hard line between them. A late fee is a flat charge triggered by a missed deadline, like $50 for every payment received after the due date. Interest is a percentage that accrues continuously on the unpaid balance, growing as time passes. Judges will not award interest when only a late fee is authorized, and they will not award a late fee when only interest is authorized.
If your agreement calls for a “penalty” without specifying whether that means a one-time charge or an accruing rate, you may end up with neither. The safer approach is to include both, each labeled clearly and calculated separately: a flat fee the moment payment is overdue, plus a running rate on the outstanding balance until paid in full.
When the Contract Is Silent: Prompt Payment Statutes
Even without a contract clause, the law may give you interest anyway. Most states have prompt payment statutes that set deadlines for construction payments and impose automatic interest penalties when those deadlines are missed. The details vary, but the structure is similar: a payment window, often 30 days after receipt of a proper invoice, and a statutory rate that kicks in automatically once the window closes. Some states tie the rate to a benchmark such as the prime rate. Others fix it by legislation, or allow the contract rate as long as it stays within the state’s usury cap.
The critical point is that these statutes can override a silent contract. If you performed the work, submitted a proper invoice, and weren’t paid on time, the statute itself may entitle you to interest.
Federal Projects
On federal government projects the rules are more explicit. Under 31 U.S.C. § 3902, any federal agency that fails to pay a contractor by the required payment date must pay an interest penalty, calculated from the day after the deadline through the day payment is actually made. The contractor does not have to request it. If the interest owed is $1.00 or more, the agency must pay it automatically.1Office of the Law Revision Counsel. 31 USC 3902 – Interest Penalties
Treasury sets the applicable rate every six months. For January 1 through June 30, 2026, the federal prompt payment interest rate is 4⅛% per year, and the same rate applies to disputes under the Contract Disputes Act.2Federal Register. Prompt Payment Interest Rate; Contract Disputes Act
The Invoice Has to Be Proper
Interest under prompt payment laws only starts running once you have submitted a proper invoice. Federal regulations list specific requirements, including your name, the invoice date, the contract number, a description of the work with quantities and prices, shipping and payment terms, your taxpayer identification number, and banking information for electronic payment. Miss any of these and the clock does not start.3eCFR. 5 CFR Part 1315 – Prompt Payment State prompt payment laws have their own invoice requirements, but the principle is the same everywhere: a sloppy or incomplete invoice gives the other party a legitimate reason to reject it and reset the timeline.
This is where contractors lose money without realizing it. If an invoice is missing a contract number or a detailed description of work, the client can dispute it as improper, and no interest accrues during the time you spend fixing the paperwork.
Usury Caps Limit the Rate
You cannot charge whatever rate you want. Every state has usury laws that cap the maximum interest rate on debts, and a contract clause that exceeds the cap is unenforceable. Consequences vary. Some states will reduce the rate to the legal maximum. Others void the interest provision entirely or impose penalties on the creditor.
The caps themselves vary widely. Some states set general usury limits as low as 6%; others allow rates above 40% for certain commercial transactions. Many states also distinguish between consumer and commercial borrowers, with higher caps for business-to-business arrangements. A rate that is lawful in one state could be usurious next door, so check the law where the project sits before setting your contract rate.
Simple vs. Compound, and How Partial Payments Apply
When a contract does not specify whether interest is simple or compound, the general common-law rule is that interest is presumed to be simple. Simple interest accrues only on the original unpaid balance. Compound interest, which accrues on both the principal and the previously accumulated interest, must be explicitly authorized in writing. If you want compounding, say so in the contract.
Partial payments raise a separate question: does the money reduce principal or interest first? The default rule is that a partial payment reduces accrued interest before it touches principal. If a client owes $10,000 in principal plus $800 in accrued interest and sends a $2,000 check, the first $800 covers the interest and the remaining $1,200 reduces the principal to $8,800. Interest then continues on the reduced balance. Parties can agree to a different allocation in the contract, but without one, this is the order courts apply.
Collecting What You’re Owed
Charging interest is one thing. Collecting it is another. The strongest construction-specific tool is the mechanic’s lien, a security interest in the property you improved, created by statute to protect unpaid contractors and suppliers. A properly filed lien covers both principal and accrued interest and makes it difficult for the owner to sell or refinance until the debt is resolved.4Cornell Law School. Mechanic’s Lien
Lien rights are easy to lose. Most states require subcontractors and suppliers to send a preliminary notice to the property owner early in the project, often within 20 to 60 days of first providing labor or materials. Miss that window and your lien rights may be gone before you know there is a payment problem. Post-completion filing deadlines are equally strict.
A standard breach of contract lawsuit is always available. You do not need a lien to sue for what you are owed, including accrued interest and, if the contract includes a prevailing-party clause, attorney fees. Under the general American rule each side otherwise pays its own legal fees, so a fee-shifting clause alongside the interest provision is one of the most cost-effective protections you can build into the contract.
For smaller balances, small claims court is faster and cheaper. Maximum claim limits range from $2,500 to $25,000 depending on the state, and some states set different limits for business plaintiffs. If the total owed, including interest, fits within your state’s limit, this route can resolve the dispute in weeks.
Retainage and Interest
Retainage is the portion of each progress payment the owner or general contractor withholds until the project is finished, typically 5% to 10%. It creates a predictable late-payment problem because contractors often wait months after completion for retainage to be released. Many state prompt payment laws address retainage directly, setting deadlines for release after substantial completion. On federally assisted projects, the prime contractor generally must release retainage to subcontractors within 30 days of receiving payment from the agency. When retainage is not released within the statutory window, interest penalties apply the same way they would for any other late payment.
Interest You Collect Is Taxable Income
Interest you collect on late payments is taxable. The IRS treats it the same as any other interest received, reportable on your return for the year it is received or accrued, whether or not anyone sends you a form.5Internal Revenue Service. Topic No. 403, Interest Received If a single client pays you $10 or more in interest during the year, that client is supposed to report it on Form 1099-INT.6Internal Revenue Service. About Form 1099-INT, Interest Income Many clients paying late-payment interest on a construction invoice do not realize they have that filing obligation, but you are still required to report the income. Track accrued interest separately from project revenue so it is not lost at tax time.