In order to enhance consumer protection, India’s central bank is implementing a system requiring banks to provide timely and transparent communication with borrowers regarding any changes to the tenor and/or EMI of their home loans.
Additionally, the RBI has mandated that lenders offer borrowers the ability to switch to fixed-rate home loans or foreclosure of loans at their discretion, with full disclosure of any related fees or charges.
The Reserve Bank of India (RBI) on Friday asked all banks and and non-banking financial corporations to give personal loan borrowers an option to switch over from a floating rate to a fixed rate regime at the time of resetting interest rates. Borrowers will also be given the choice to opt for enhancement in EMI or elongation of the tenor.
According to RBI personal loans refers to loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc.).
Interest rates have risen since May last year as the central bank hiked the repo rate to tame high inflation. As a result of 250 basis points increase in the repo rate from May 2022 till February this year, a large number of borrowers have been facing negative amortisation, wherein the Equated Monthly Instalment (EMI) works out to be less than the interest obligation, resulting in persistent increase of the principal amount.
The RBI mandate in a nutshell
RBI has now made it mandatory that at the time of sanctioning a loan, the bank will have to convey in writing to the borrower the impact of a rate change. So, whenever the repo rate is hiked by the RBI, the lender will have to provide an option to the borrower if he wants to increase the EMI or the tenor. Similarly when the RBI cuts rates, banks will have to ask the borrower if he wants a lower EMI or a reduced tenure.
” RBI has been very clear on separating penal charges and penal interest charged to the customers. The Credit Card and Debit Card – Issuance and Conduct Directions, 2022 master circular in December did away with negative amortization of penalties for credit card. With the new draft in April this year, the RBI is clear it doesn’t want penalties to compound as interest. Not every lender does it, but now the RBI wants conformity. A penal charge is usually used to encourage credit discipline, and the RBI wants to ensure the lenders use penalties only to that extent. This is a borrower-friendly move by the RBI,” said Adhil Shetty, CEO, BankBazaar.com
In case of home loans, the lenders do have the liberty to reset the credit risk component of the interest charged to the customer based on credit profile of the customer. This means that the lender can increase the rate of interest for the borrower if they default on the loans without resorting to compounding penal interest.
Here are the new changes that need to be implemented
1. At the time of sanction, REs have to clearly communicate to the borrowers about the possible impact of change in benchmark interest rate on the loan leading to changes in EMI and/or tenor or both. Subsequently, any increase in the EMI/ tenor or both on account of the above must be communicated to the borrower immediately through appropriate channels.
At the time of sanction of EMI-based floating rate personal loans, banks must take into account the repayment capacity of borrowers to ensure that adequate headroom/ margin is available for elongation of tenor and/ or increase in EMI, in the scenario of possible increase in the external benchmark rate during the tenor of the loan.
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2. At the time of reset of interest rates, financial institutions have to provide the option to the borrowers to switch over to a fixed rate as per their Board approved policy. The policy, inter alia, may also specify the number of times a borrower will be allowed to switch during the tenor of the loan.
3. The borrowers must be given the choice to opt for (i) enhancement in EMI or elongation of tenor or for a combination of both options; and, (ii) to prepay, either in part or in full, at any point during the tenor of the loan. Levy of foreclosure charges/ pre-payment penalty shall be subject to extant instructions.
4. All applicable charges for switching of loans from floating to fixed rate and any other service charges/ administrative costs incidental to the exercise of the above options have to be transparently disclosed in the sanction letter and also at the time of revision of such charges/ costs by the REs from time to time.
5. REs shall ensure that the elongation of tenor in case of floating rate loan does not result in negative amortisation.
Amortisation is the process of paying off debt over time in regular installments of interest and principal sufficient to repay the loan in full by its maturity date. Negative amortization means that even when you pay, the amount you owe will still go up because you are not paying enough to cover the interest.
6. REs have to make accessible to the borrowers, through appropriate channels, a statement at the end of each quarter which shall at the minimum, enumerate the principal and interest recovered till date, EMI amount, number of EMIs left and annualized rate of interest / Annual Percentage Rate (APR) for the entire tenor of the loan.
Borrowers have complained that banks normally change or reset the EMIs in an arbitrary manner and tenors are extended without informing the borrowers. Further, borrowers are not informed about the foreclosure charges.
According to Bankbazaar, in the case of a Rs 50 lakh loan with 7 per cent interest rate in May 2022, with a 15-year EMI, the repayment period would have gone up by 90 months if the EMI amount was kept unchanged, after the repo rate was increased to 6.5 per cent from 4 per cent.
“The RBI’s measures are intended to empower borrowers to make informed and deliberate decisions regarding their home loan repayment. These measures come after a year of heightened inflation which has caused a big spike in lending rates, which in turn have caused big spikes in loan tenors or EMIs, and sometimes, both,” said Shetty.