Why you must thank RBI for ending penalties on pre-paying home loans

The Reserve Bank of India has given millions of loan borrowers respite from pre-payment penalties.It had done away with pre-payment penalty on home loans long ago. This time, the apex bank has instructed all banks to abolishpre-payment penalty on all floating interest loans. The ruling applies to home loans, corporate, vehicle and personal loans, auto loans, personal and education loans that are repaid with a floating rate of interest.

RBI’s new regulations, especially on prepayment penalties, have brought a lot of cheer for the common man.In its first bi-monthly monetary policy statement for 2014-15, the RBI has directed banks to consider allowing their borrowers the facility of prepaying floating rate term loans without any penalty."...it is advised that banks will not be permitted to charge foreclosure charges or pre-payment penalties on all floating rate term loans sanctioned to individual borrowers, with immediate effect," RBI said in its notification.

Prepayment penalty has been a demotivating factor to all loan customers, whenever they are in a position to pre-pay their loans. Especially, home loans are usually in lakhs and even a pre-payment penalty of 2 per cent of the total loan amount causes a big dent on your pockets – on a 20 lakh loan, it would comet Rs 40,000. Thanks to the RBI, you don't have to pay such huge sums of money to repay your loan. 

Many of you tend to go for pre-payment of loans when you find that interest rates show a continuous upward movement. Some of the customers opt for switch-over of their loans with existing banks to the lenders offering lower interest rates on loans.

Banks and other lending institutions have been very reluctant to part with the extra interest charge on the pre-payment charges on loans as it is their main source of income. The expansion plans of these institutions usually hinge upon their income on loan repayments. So, if you pre-repay your loan, in part or in totality, they lose a lot of their future income. So, customers are discouraged by banks to close off loans by way of levying-these penalties with considerable monetary implications.

As the prepayment penalties now-stand annulled, lending institutions would have to explore channels of raising their funds from alternative resources. But it is not that much of your concern as borrower.

As mentioned earlier, the RBI had forbidden foreclosure charges or pre-payment penalties on home loans on floating interest rate basis. The move aimed at ending the discrimination between existing and new borrowers and bringing uniformity across the banking system in the home loan segment, which was a logical course. Now the benefit same has been extended to floating rate term loans, which will help small and medium enterprises as well. Banks will no more be allowed to deny the benefit of lower loan liability to all their customers.

So, you have every reason to profusely thank the RBI for ending penalties on pre-paying all debts taken on floating interest rates, including home loans.