Eliminating pre-payment penalty on loans might encourage banks to increase interest rates on loans to pass on their load on to the customers, according to RBI Deputy Governor Usha Thorat.
She said, “There is a chance that banks may pass on this burden to customers (if the prepayment penalty is abolished)”.
A prepayment penalty is a clause in the loan contract with the lender that says if the customer terminates the loan prior to maturity, he will end up paying a penalty. Penalties are normally calculated as a percent of the unpaid balance when making a prepayment or interest for particular period of months.
Normally, availing of a prepayment penalty clause in the contract helps the customer get loans at the reduced interest rates since it indicates the high credit rating of the customer.
Anti-monopoly regulator Competition Commission of India had just said that it considered penalizing borrowers choosing to terminate their loans pre maturely is a breach of competition laws and that it would penalize banks or ask them to give up levying pre-payment penalty on borrowers.
Talking about this topic Thorat said that the commission had interfered in the process as some banks were charging large sums of penalty on borrowers due to prepayment of loans.
Normally these penalties lie in the range of 2-3%. If they are not levied, the interest rate income would be disturbed and can raise lending risk, state banks. If that happens, banks might be forced to increase lending rates to all borrowers to make up for this risk, say the bankers.
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