Banks to decide on ending loan pre-payment penalty

By Falaknaaz Syed Oct 23 2011 , Mumbai 


Close on the heels of the National Housing Bank (NHB) waiving off prepayment penalty on old home loan borrowers and pressure mounting from the Reserve Bank of India (RBI) on banks to follow suit, the management committee of Indian Banks’ Association (IBA) will be meeting on October 25 to decide on the next course of action.

The RBI is already contemplating such a move and had said that it will wait for the comments from IBA on its proposal to do away with prepayment penalty on floating rate home loans. Recently, the Banking Ombudsmen Conference suggested that banks should not impose prepayment charges on loans with floating rate of interest.

More than 95 per cent of borrowers have taken home loans on a floating rate basis. Banks charge 1.5 to 4 per cent of the loan outstanding as prepayment charges from home loan customers.


In a circular last week, NHB told housing finance companies (HFCs) that they cannot charge prepayment penalty where the housing loan is on a floating interest rate basis (pre-closed through any source). For home loans that are on fixed interest rate, HFCs cannot charge a prepayment penalty if the loan is pre-closed out of one’s own sources. However, if a fixed rate loan is pre-closed through bank’s source, then a prepayment penalty will be charged. In case a loan is on fixed-cum-floating rate, the rules for fixed loans will apply till the time your loan is fixed, followed by floating loan rules.

In addition, the housing finance regulator has also instructed HFCs to apply uniform rate of interest rates on floating interest rate loans to old and new borrowers with the same credit profile.

With RBI increasing key policy rates by 350 basis points since March 2010, home loans rates on an average have risen by 250-300 basis points (2.5-3 per cent) for floating rate customers. Banks, however, offer reduced rates to new customers.

Leading players such as State Bank of India, Canara Bank, Dena Bank, Bank of Baroda, Allahabad Bank, Corporation Bank, Central Bank of India and UCO Bank have slashed interest rates by 0.25-0.5 per cent on home and car loans for new customers for the festival season besides waiving processing fee, documentation fee and prepayment penalty to pep up demand.

RBI has repeatedly told banks that such practices are discriminatory against old borrowers. In an informal discussion with IBA, RBI had voiced similar concerns.

An RBI spokesperson said, “If a bank can offer a lower rate and waive processing fee or prepayment penalty for a new customer, there is scope to extend these benefits to an existing borrower too.”

A senior official of IBA said, “In a liberalised environment, banks should be free to price their loans.”

Last month, IBA wrote to RBI in response to the recommendations made by the Damodaran Committee report saying that there is an economic rationale for levying prepayment charges. The Damodaran Committee had mentioned that “foreclosure charges are seen as a restrictive practice deterring the borrowers from switching over to cheaper available sources... especially when some banks are offering lower interest rate benefits to new customers”.