Stop pre-payment charges immediately, RBI tells banks

Mumbai: The Reserve Bank of India (RBI) said on Tuesday that banks should stop charging advance payment penalties on floating-rate home loans with immediate effect.

RBI had already warned banks not to levy foreclosure charges or pre-payment penalties on home loan customers in its monetary policy on 17 April. The deadline was set in a notification posted on its website on Tuesday.

The proposal to stop these charges was put forward by a panel headed by former capital market regulator chief M. Damodaran on customer service in banks. After the panel’s recommendations, many banks voluntarily withdrew the charges but some continued with the practice. The committee had observed that such charges are resented by home loan borrowers across the board since banks were found to be “hesitant in passing on the benefits of lower interest rates to the existing borrowers in a falling interest rate scenario”. Banks had earlier lobbied RBI for the continuation of these charges. In September last year, the Indian Banks’ Association (IBA) lobby group wrote to RBI arguing against the removal of advance payment charges, fearing mismatches in liquidity.

Banks usually charge 2-4% of the loan outstanding as early repayment charges from mortgage holders. The charges do not let a customer close the loan with the existing bank and move on to another bank that offers cheaper loans.

The waiver of the advance payment penalty will help customers in that effort. Such charges are not a hindrance for fixed-home loan customers as they know their monthly instalment already and these don’t fluctuate with interest rate changes. However, banks are reluctant to offer fixed-rate loans to customers because of the possibility of mismatches in their assets and liabilities when the interest rate fluctuates. Hence, at least 95% of home loans bear a floating rate of interest, RBI data show.

“The removal of foreclosure charges/prepayment penalty on home loans will lead to reduction in the discrimination between existing and new borrowers and competition among banks will result in finer pricing of the floating rate home loans,” the RBI notification said.

“It’s a step in the right direction but RBI has to clarify whether people who took dual-rate loans and shifted from a fixed to a floating rate will have to pay a penalty. NHB (National Housing Bank) in a notification some weeks back had clarified that a penalty will be charged for such dual loans and if RBI also says the same thing then it will be a step backwards,” said Harsh Roongta, founder and CEO, Apna Paisa, a personal finance website. NHB is the regulator for housing finance companies.

joel.r@livemint.com