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ARTICLE · 27 AUGUST 2026

Lenders Beware - When A High Interest Rate May Be Void As A Penalty

When does a high default interest rate cross the line from legitimate compensation to an unenforceable penalty? A recent NSW Supreme Court case examines the principles governing default interest provisions in loan agreements, revealing the critical factors lenders must consider when structuring their interest rate terms. The decision provides essential guidance on what evidence lenders need to justify material increases in default rates and how courts will assess whether such provisions constitute genuine p

AustraliaFinance and Banking

Lenders rely on interest rates to cover the cost of lending to customers. This includes scenarios when the loan is for a short term period. However, there are circumstances when use of a high interest rate on default will be found to be void as a penalty.

The law against penalties focusses on whether the relevant provision in a contract operates as a genuine pre-estimate of loss or as a punishment for breach. If an interest clause, for example, stipulates payment of a sum that is extravagant, unconscionable, or out of all proportion to the loss likely to be suffered, it may be characterised as a penalty and found to be unenforceable. The party asserting a clause is a penalty, bears the onus of proving it but that onus will shift to the lender where the difference in the standard and default rate is disproportionate enough.

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