There are lots of financial terms out there that take complicated concepts and reduce them down to a single word. "Arrearage" is one of them, and if you find yourself in arrearage, it's going to depend highly on context whether it's a good or bad thing. Read on to learn more about this term and the contexts in which it's commonly used.
What is arrearage?
Arrearage, generally speaking, is when something is past due, whether that's your rent or an overdue loan payment. However, sometimes, things are simply paid "in arrears" as a matter of course, like real estate taxes. In this situation, real estate taxes are simply owed at the end of the year for which they're due -- and this is standard practice.
There's no reason to worry about arrearage unless it's problematic, so if you encounter this phrase, the first thing to ask yourself is about the context. A bill for plumbing work due in arrears, as a matter of course, is not an issue if that's the agreed-upon payment arrangement. Rent being in arrears is a huge problem and can lead to eviction.
Arrearage in business
Often, companies pay their bills in arrears to help maximize their cash flow. Not only can they invest their cash to help it make more money, but it also gives them a chance to accumulate extra cash, rather than having to possibly scramble during a thin period.
This also helps when the company's clients or tenants go into arrears. In this case, it's not as good of a deal because it means that the bills are past due without prior agreement, and that can make for difficult accounting. Companies will always have some amount of arrearage, but too much can be a big red flag for investors.
Arrearage in financial instruments
There are lots of examples of arrearage in finance; some are expected, others are not, and the context really does matter here. Here are a few places where you may encounter arrearage:
- Calls on shares. If your calls come due and you can't make your payment, you'll be in arrears. This has pretty serious consequences, including penalties and the forfeiture of the share, including the portion of the shares you've already paid.
- Dividends. If dividends are due but have not yet been paid to preferred shareholders, they're said to be in arrears. These are disclosed on financial statements and must be paid in full before dividends can be paid to common shareholders.
- Interest payments. Whether you're earning interest or paying it, interest is generally paid in arrears. So, your mortgage interest is due after it's been accumulated, making it due in arrears, but the interest on your bonds will also pay in arrears, generally at maturity.
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Why arrearage matters to investors
Arrearage may or may not be pretty important to you as an investor, depending on what kind of investments you make and what sort of arrearage you're encountering.
If you own real estate investment trusts (REITs), for example, arrearage that is from past-due rents is a serious problem because it represents both tenants who aren't paying and those who may have to be forcefully evicted, which can incur additional substantial costs. If the arrearage is serious and high, it could point to a major problem with your property management team's vetting methods for its tenants. However, some amount of arrearage is normal most of the time.
If your investments are in bonds, you'll encounter arrearage that's perfectly normal and expected. Every bond investor is paid interest in arrears at the maturity of their bonds; this, too, is just par for the course.
For investors in manufacturing, retail, or similar businesses, you may see arrearage in the form of payments the companies are making to their vendors. This is pretty normal behavior and helps your companies do more with their money in the window between the time when the order is placed and when the bill becomes due after delivery.
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