Give fixed rate option on EMI-based loans while resetting rates: RBI

The RBI on Friday directed banks to allow individual borrowers paying loans through EMIs to opt for fixed interest rate system or extension of loan tenor, a move aimed at preventing loanees from falling into the trap of negative amortisation, in wake of rising interest rate.

The interest rates have moved northward since May 2022 after the central bank started raising the benchmark lending rate (repo) in a bid to check inflation following the outbreak of the Russia-Ukraine war.

As a result of 250 basis points increase in the repo rate, a large number of borrowers faced 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.

RBI said that at the time of sanction of EMI-based floating rate personal loans, banks and NBFCs should take into account the repayment capacity of borrowers to ensure that adequate headroom is available for elongation of tenor and/ or increase in EMI, if interest rate rises.

Home, auto and other personal loans are linked to external benchmark rates, like repo rate.

RBI said several consumer grievances have been received in relation to elongation of loan tenor or increase in EMI amount with regard to EMI-based floating rate personal loans, without proper communication or consent of the borrowers.

"At the time of reset of interest rates, REs shall provide the option to the borrowers to switch over to a fixed rate as per their Board-approved policy. The policy...may also specify the number of times a borrower will be allowed to switch during the tenor of the loan," RBI said in a circular to banks and NBFCs, including housing finance companies.

It further said at the time of sanction, regulated entities (REs) should 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 shall be communicated to the borrower immediately through appropriate channels," RBI said.

Banks and NBFCs have been asked to ensure compliance of the instructions for the existing as well as new loans by December 31, 2023.

Also, the borrowers should be given a choice to opt for enhancement in EMI or elongation of tenor or for a combination of both options; and to prepay, either in part or in full, at any point during the tenor of the loan. Levy of foreclosure charges/ pre-payment penalty should be subject to extant instructions.

"REs shall ensure that the elongation of tenor in case of floating rate loan does not result in negative amortisation," the circular said.

Futher, REs should make accessible to the borrowers a statement at the end of each quarter containing details like the principal and interest recovered till date, EMI amount, number of EMIs left and annualised rate of interest / annual percentage rate for the entire tenor of the loan.

Banks and NBFCs have been asked to ensure compliance of the instructions for the existing as well as new loans by December 31, 2023.