Financial institutions keep the economy running smoothly. From offering loans and credit to helping individuals and businesses manage their finances, they are at the heart of everyday financial transactions. However, providing finances also means that these institutions are putting themselves at the risk of losing money due to defaults and late repayments. So, to protect themselves, they have various mechanisms in place.
One such mechanism is penal interest, a concept that often arises in the context of loans, mortgages, and credit facilities. In this article, we’ll take a closer look at penal interest charges, why they are used, and how they affect both lenders and borrowers.
What is Penal Interest?
Penal interest, meaning an additional interest charged on loan or credit card payments is levied by financial institutions to borrowers who fail to make payments in accordance with the agreed-upon terms. The interest is attracted in case of delays in installments or EMIs, and serves as a deterrent to late payments, non-payment, or other forms of default that might occur during the life of the loan agreement. The main purpose of this interest rate is to promote accountability and punctuality among borrowers and safeguard financial institutions against loan fraud.
How is the Penal Interest Calculated?
The financial institute can charge a penalty either on the entire outstanding amount, or as a percentage of the missed loan installment.
In case the interest is levied on the outstanding amount, the applicable penal rate is identified as per the loan agreement, and added to the existing interest rate to levy a new and higher rate on the outstanding loan.
For example, if the loan is borrowed at 12% p.a, and penalty rate of 3 is attracted due to delayed payment, the new interest rate will be 15% p.a for the remaining amount.
In case that the penalty is charged as a percentage of the missed installment, the penal rate is multiplied by the EMI amount to calculate the new amount due. For example, if you have a loan with an EMI of Rs. 50,000 which is delayed, at a late payment rate of 24% p.a., the penalty will be Rs. 1,000.
The GST Authority has imposed a GST of 18% on such payments. Once the penal interest amount is calculated as per the overdue amount and duration, GST would be applicable. So, in the example above, the total penalty will be Rs. 1,180 after including the 18% tax.
Can the Penal Interest Rate be Withdrawn?
In many cases, if the borrower displays punctuality in payment of subsequent installments, the hiked interest rate can be reduced or withdrawn for the outstanding amount at the discretion of the financial institution. However it is recommended that these circumstances are discussed at length and clarified before acceptance of the loan.
How does the Law Protect the Borrowers?
While these charges and interests serve to safeguard financial institutes, there are regulations in place to ensure that they are used fairly and transparently.
The RBI states that in case of default in payment, only penal charges may be applied, and they shall be reasonable and levied by the lenders only on the amount under default in a non-discriminatory manner as per their Board approved policy. Further, it must be ensured that there is no capitalization of the penal charges, meaning no further interest computed on such charges. This policy prevents accumulation of excessive charges that could push borrowers into deeper financial distress.
What are Some Other Types of Penal Charges?
Financial institutes levy penalties primarily on delayed or non-payment of loan installments, but the borrower can also attract the following fees:
- Bounce charges or NSF charges, levied to recover processing fees when the payment cannot be completed due to insufficient funds in your account.
- Over-limit charges occur when a borrower exceeds their credit limit or surpasses the approved limit on their hybrid term loan facility.
- Early repayment fees, which are charged to the borrower on early lump-sum repayment of all pending loan installments, to penalise them for the missed future interest payments.
It is crucial that the borrower discusses all the above penalties and the circumstances for their application with the lending institute before entering into a legal loan agreement.
Final thoughts
A robust risk mitigation framework helps financial institutions maintain a stable revenue stream, in turn offering stability and protection to its customers who trust them with their wealth. Therefore, it is important to choose a financial institution that prioritises transparency and trust in its dealings.
At Tata Capital we have a team of financial experts ready to guide you through the loan application process and ensure that you are aware of your options before you make your decision, and our personal loan is offered with an easy online approval system to streamline your application.
Learn more about our low personal interest rates and flexible repayment options by visiting the Tata Capital website, or download the app.
FAQs
Penal charges in OD refer to additional charges levied by financial institutions on an overdraft (OD) account when a customer exceeds their credit limit or fails to make timely payments.
Penal charges are levied on a missed loan installment. The rate of charge is specified in the loan agreement, and the charges are calculated as a percentage of the installment amount. The borrower must pay excess on the installment as well as any applicable taxes.
Making exact and timely payments in accordance with your loan agreement is the best way to avoid paying penal charges. You may enquire at your financial institute about setting up payment alerts to stay on top of your installment schedules.
Below is a summary of key penal charges at Tata Capital.
For default in payment of interest and/ or principal amounts it is 3% per month on defaulted amount (Annualized Penal Charge of 36%). For Dishonour of any cheque/ payment instruments, At Tata Capital, we charge a nominal amount of Rs. 600 for every Cheque/Payment Instrument Dishonour. For Mandate Rejection Service Charge, Tata Capital charges a nominal amount of Rs. 450 + GST
18 March 2025
5 mins read
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