ATM :: Overdraft will attract foreclosure charges

Ban on pre-payment penalty applicable only on floating rate loans such as auto or personal loan
Rahul Soota | June 21, 2014  |Last Updated at 21:10 IST | Business Standard


Last month, the Reserve Bank of India (RBI) directed commercial banks to do away with foreclosure charges on all floating rate term loans sanctioned to individuals. This comes as a major relief to retail borrowers given that foreclosure penalties are in the range of two to five per cent of the outstanding amount on such loans until now. Car loans, personal loans, loans against property, gold loans, two-wheeler loans and education loans are some of the popular retail loans.

This move comes two years after the RBI abolished pre-payment penalties on floating rate home loans. The directive on home loans was a relief to all home loan borrowers as it opened up possibilities to re-finance existing loans from another lender at lower rates or just pre-pay their loans entirely, ahead of time, without incurring any penalties. It is pertinent to note that the recent directive on floating rate retail loans is not all encompassing. Let us see if you stand to benefit.

Individual borrowers
While the RBI’s directive to do away with pre-payment penalty is applicable to all types of floating rate loans, it is forcibly applicable only for individual borrowers. By definition this would also include sole proprietors. But if the borrower is a partnership firm, company or a Hindu Undivided Family, then banks are not obliged to pass on the benefit of no foreclosure charges. Even where the main borrower is an individual and the co-borrower or guarantor is a non-individual, the benefit would not accrue.

Floating rate term loans
Interest on your loan could be floating, semi-fixed or fixed rate. Only floating rate loans stand to benefit under the new regime. Pre-payment penalty, if part of your contract, would still be applicable on semi-fixed loans till such time they automatically attract a floating rate of interest during their life cycle, as stipulated in your loan agreement.

Overdraft facilities would also fall outside the ambit of this recent relaxation, as only term loans are presently covered.

The enclosed table lays out various types of loans provided by banks and the pricing methodology followed. Public sector banks have moved entirely to floating rate pricing for their suite of retail loans. Private sector and foreign banks tend to price their shorter tenor loans (generally up to five years) as fixed rates and longer tenor ones (which could go up to 15 years) as floating rate.

Borrowers of PSU banks like State Bank of India or Punjab National Bank would be able to save on pre-payment penalties on all the above mentioned loan categories, with immediate effect. It is possible that your prevailing loan contract does not provide for such penalties, as these banks have been moving to a penalty free regime over the past few years. On the other hand, borrowers from private sector and foreign banks (for loans that are fixed rate loans), would still need to pay a foreclosure charge, where their loan agreement requires them to do so.

Existing loans and fresh loans
This latest directive by RBI brings in uniformity, greater transparency and brings new as well as existing borrowers on the same plane.

In other words, the pre-payment waiver directive will benefit existing borrowers as well as new borrowers. So you are within your right, if you meet the criteria explained above, to seek nil pre-payment charges with immediate effect, thanks to the regulatory diktat. Needless to say that new loan contracts will not have a provision for pre-payment penalties, for individual borrowers of floating rate term loans from banks.

Banks, NBFCs and HFCs
At the moment, only commercial banks have been directed to offer this advantage to their customers. Borrowers of Non-banking Finance Companies (NBFCs) and Housing Finance Companies (HFCs) will not be able to claim relief from pre-payment penalties, if their loan agreement provides for such charges to be paid.

This is a departure from the past, when National Housing Bank (NHB) had asked all HFCs to provide the benefit of nil pre-payment charges on home loans to their borrowers. One can only hope that RBI might instruct NBFCs as well and that the NHB could follow suite with HFCs, to extend these benefits to their customers as well.

Times are changing
Retail loans have been an area of growing interest in the new millennium. Ever increasing demand, decent margins, improving credit performance, lower cost with improvements in technology and processes, etc have made this category a focus area for lenders. Increasing competition and regulatory scrutiny have driven customer friendly practices like clarity on terms and conditions, better collection practices, lower interest rates, festival offers with lower or nil processing fees, improved customer service and much more.

Pre-payment penalties have been a bug bear for customers and lenders have been relaxing this as the regulatory position and intent was made clear two years ago, with the home loan category (having the largest share of retail loans).

It is common to find loan offers from private sector banks which might have fixed interest rates, to provide for nil pre-payment penalty after the first six or 12 months. For instance, Bajaj Finserv, an NBFC, has made nil pre-payment a selling point for several of their retail loan categories. HSBC has take the recent RBI directive as a clear signal of intent and extended the benefit of zero foreclosure charges to non-individual borrowers as well under their loan against property scheme. In the coming months, we could expect similar steps from a slew of lenders, as borrowers begin to demand such concessions.

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