I own a rental property and the tenant has been late on rent on a number of occasions. I have been kind and respectful, but she always makes an excuse although she has a job and the means. The contract clearly says she must pay a late fee but I never charged it until now. Lately I was considering to charge it, so that she starts paying on time, but I read somewhere it may be haraam (unlawful) because it is interest. Interest, as I understand it, is the cost of borrowing money, the longer the debt is held, the greater the interest. In the case of the late fee, whether she is late 1 day, 5 days, 10 days or more, the late fee will be the same amount. Hence, once the time of rent being due is passed the late fee is charged, but it does not increase with more time. Is late fee really interest? May I charge it, or is it unlawful?
Before the fiduciary monetary system (paper money system), money was made of gold or silver, which are precious metals. Therefore, any amount of increase added on the principal was obviously interest. However, purchasing power is the criterion in the current paper money system. In order to comply with the expression “neither you do wrong, nor you are wronged (al-Baqarah 2:279)”, the purchasing power of the loaned/owed money or rent must be fixed. The loss of purchasing power may be calculated by considering the inflation rate.
In your case, a fee that serves to compensate for the purchasing power loss that is caused by the late rent is NOT included in the scope of interest. Any amount more than that is counted as interest, and it must be avoided.