Banking leader State Bank of India dropped ‘prepayment charges' on all its loans over the past fortnight.

Mon, 02 May 2011 00:35:12 -0600 

The much-talked-about prepayment penalty on home loans is on its way out.

Banking leader State Bank of India dropped ‘prepayment charges' on all its loans over the past fortnight. The announcement conincided with the hiking of the bank's base rate and withdrawal of the controversyal teaser home loan schemes.



With the SBI taking the lead, other banks are now expected to follow suit and withdraw the controversial penalty in the days to come.

Most banks and home finance institutions charge a prepayment penalty in the range of 1 per cent to 2 per cent in the event of a customer opting to close the home loan prematurely.

Public sector banks generally charge about 1 per cent or less of the loan outstanding as prepayment penalty, while it can be anywhere between 1-3 per cent in private banks. In many cases, banks do not charge any prepayment penalty if you prepay using your own sources.

The penalty is calculated on principal. Hence, if you have Rs 20 lakhs of loan outstanding, the penalty could range from nothing to Rs 60,000 depending on the bank.

Last year the issue had come under the purview of the Competition Commission of India. After a long hearing, the banks managed to make a strong case for retaining the charge, saying they charge it with a view to covering the interest loss due to the foreclosure of the loan.

They said prepayment penalty helps them mitigate the costs of deposits taken at higher rate which they do not have a right to prepay.

It also covers for the cost incurred in legal and technical services and origination fees. Banks work out agreements assuming such costs can be recovered over the full tenure of the loan, which prepayment jeopardises.

The Competition Commission later ruled that the levy of prepayment penalty by banks on home loans is not against competition laws. A majority decision given by the four-member Commission on December 2, 2010 said banks and housing finance companies have not violated Section 3 and 4 relating to anti-competitive practices and abuse of dominant position.

However, two of the members issued dissenting orders suggesting that banks should discontinue with the practice of charging such a penalty.

Earlier, the Reserve Bank of India had gone on record expressing its dissent over the practice of slapping penalty charges on premature repayment of loans. The apex bank had said it did not approve of such charges.

"RBI does not approve of charging penalty or foreclosure charges. We have advised banks to lay out appropriate internal principles and procedures so that usurious interest including processing and other charges are not levied by them on loans and advances," RBI had said in response to a query filed under the Right to Information Act.