Reserve Bank of India Releases New Guidelines for Home, Car Loan After Increase In Repo Rate

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Reserve Bank of India (RBI) has released a new set of guidelines which instructs banks and non-banking financial institutions (NBFCs) on how they can charge penalty to borrowers for non-payment and how loan takers can shift to fixed interest loans from floating interest loans.

These guidelines come after the Reserve Bank of India (RBI) increased the repo rate by 2.5% within the last 18 months.

What is a repo rate?

Repo is the short form of ‘repurchase option’ or ‘repurchase agreement’. Repo rate is the rate at which the central bank of a nation, Reserve Bank of India (RBI) being India’s central bank, lends money to commercial banks against government securities.

Monetary authorities use repo rates as a method to compensate for the deficiency of funds during inflation. This measure is taken to demotivate banks from borrowing money from the central bank, reducing the supply of money in the economy resulting in adjusting inflation.

What does an increased repo rate mean for borrowers?

Banks have been asked to convey the interest rate hike to borrowers with three options to adjust to the increased interest rate:

Borrowers can increase the tenure of their loan, which is the default option. Some people have already seen their tenure increase by 5 or 10 years over the past few months.
Borrowers can increase their EMIs to match with the increased interest rate, which is an option recommended by experts if it’s an affordable option, because it would decrease the interest outflow.
Reserve Bank of India (RBI) has also provided an option for borrowers to switch to fixed-rate loans. This type of loan is not popular in India because it is difficult for lending institutions to price 20-year interest rate risk, so they have been significantly more expensive than a floating rate loan. Fixed rate loans are typically 2% higher than floating rate loans.

How will banks charge penalties on defaulters?

The new rules on penalties will be applicable to all types of loans, for example, vehicle loans, home loans, loans against property, personal loans, any loan that has been taken by an individual borrower.

RBI’s new rule has instructed banks to transparently disclose the penal charge for a late payment, but this charge cannot be capitalized. This means the added charge on next month’s loan cannot be added to the outstanding principle. RBI has also said that banks cannot charge a penal interest over the normal interest anymore.