No foreclosure charges, prepayment penalties on floating rate loans: RBI

23 Feb 2025, 09:01 PM

The RBI wants lenders to eliminate foreclosure charges or pre-payment penalties on all floating rate loans availed by individuals and micro and small enterprises.

Team Head&Tale

The Reserve Bank of India (RBI) has issued a draft circular, proposing new guidelines with regard to the levy of foreclosure charges and pre-payment penalties on loans.

According to the circular, the RBI wants all regulated entities (REs) to eliminate foreclosure charges or pre-payment penalties on all floating rate loans, including those for business purposes, availed by individuals and micro and small enterprises (MSEs).

As per the extant instructions, certain categories of lenders are not permitted to levy foreclosure charges or pre-payment penalties on floating rate term loans sanctioned for purposes other than business, to individual borrowers with or without co-obligants.

The draft circular said that the RBI’s supervisory reviews have indicated divergent practices among REs with regard to the levy of foreclosure charges or pre-payment penalties on loans sanctioned to MSEs, leading to customer grievances and disputes. 

“Additionally, some REs have been found to include restrictive clauses in loan contracts/ agreements to deter borrowers from switching to another lender for lower interest rates or better service terms," RBI said.

Based on a review of supervisory findings and industry feedback, revised regulations are being issued for all REs regarding the levy of foreclosure charges, and pre-payment penalties on loans.

“REs, other than Tier 1 and Tier 2 Primary (Urban) Co-operative Banks and Base Layer NBFCs, shall not levy any charges/ penalties in case of foreclosure/ prepayment of floating rate loans granted to individuals and MSE borrowers, with or without co-obligant(s), for business purpose,” an RBI’s draft circular said.

"However, in the case of MSE borrowers, these instructions shall be applicable up to an aggregate sanctioned limit of Rs 7.50 crore per borrower," the circular further noted.

These instructions shall apply irrespective of the source of funds used for foreclosure/ pre-payment of loans, whether partial or in full, the circular said.

For loans with dual, special rate structures (combination of fixed and floating rates), the applicable foreclosure, and pre-payment conditions will depend on whether the loan is on a fixed or floating rate at the time of foreclosure or pre-payment.

“In cases where foreclosure charges/ pre-payment penalties are permitted, they shall be levied as per the Board-approved policy of the REs. Such charges/ penalties shall be based on the outstanding amount in the case of term loans and the sanctioned limit in the case of cash credit/ overdraft facilities,” the circular said.

"REs should permit foreclosure/pre-payment of loans without stipulating any minimum lock-in period." They should not levy any charges/penalties in cases where foreclosure/ prepayment is effected at the instance of the RE. 

According to the circular, lenders regulated by the RBI should also not levy any charges retrospectively at the time of foreclosure/prepayment of loans, that were waived off by the REs/not disclosed in advance to the borrowers, under any circumstances.

The central bank has invited comments from stakeholders by March 21, 2025.