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Tata Capital > Blog > Generic > Penal Charges Meaning – What are the penal interest rates & charges in loans?

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Penal Charges Meaning – What are the penal interest rates & charges in loans?

Penal Charges Meaning – What are the penal interest rates & charges in loans?

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 charges, 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 charges meaning, why they are used, and how they affect both lenders and borrowers.

What are penal charges?

Penal charges, meaning an additional fee charged on loan or credit card payments by financial institutions to borrowers who fail to make payments in accordance with the agreed-upon terms. The fee 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 fee is to promote accountability and punctuality among borrowers and safeguard financial institutions against loan fraud.

Penal charges calculation: How the penal interest rate & penal fee are applied

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 a 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 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 charges 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 charges 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 be 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 institutions, 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 is computed on such charges. This policy prevents the accumulation of excessive charges that could push borrowers into deeper financial distress.

Types of penal charges: Bounce charge, penal fee, overlimit, prepayment penalty

Financial institutions levy penalties primarily on delayed or non-payment of loan installments, but the borrower can also attract the following fees:

  1. Bounce charges or NSF charges are levied to recover processing fees when the payment cannot be completed due to insufficient funds in your account.
  2. Over-limit charges occur when a borrower exceeds their credit limit or surpasses the approved limit on their overdraft facility.
  3. Early repayment fees, which are charged to the borrower on early lump-sum repayment of all pending loan installments, to penalize 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 institution before entering into a legal loan agreement.

Penal charges in banking: Common scenarios when you pay a penalty fee

The common scenarios in which you need to pay the penal charges in loan accounts include:

  1. Late EMI or loan payment: If you miss your loan EMI or credit card payment due date, it can attract a penalty and extra interest.
  2. Insufficient account balance: If you don’t maintain the required minimum balance in your savings account, lenders may levy monthly penalty charges.
  3. Cheque bounce: If a cheque is returned due to a low balance or signature mismatch, banks charge a cheque bounce penalty.
  4. Credit card overlimit usage: Spending more than your approved credit limit leads to an overlimit fee.
  5. Loan agreement violation: If you don’t follow the loan terms, such as misuse of funds or delayed documents, it can result in penal charges in the loan.

How to avoid penal charges in loan EMIs: Best practices in India

The best practices to avoid penal charges on your loan include:

  1. Set auto-debit instructions: Activate ECS or NACH to ensure EMIs are paid on time every month.
  2. Maintain sufficient bank balance: Make sure your account has enough funds when the EMI is due.
  3. Track EMI due dates: Note down or set reminders for your EMI payment schedule.
  4. Pay EMIs before the due date: Early payment helps avoid last-minute issues or bank delays.
  5. Inform the lender in advance: If you face financial trouble, contact the bank early to discuss solutions.

Conclusion

A robust risk mitigation framework helps financial institutions maintain a stable revenue stream, in turn offering stability and protection to their customers who trust them with their wealth. Therefore, it is important to choose a financial institution that prioritizes 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. Our personal loan is offered with an easy online approval system to streamline your application.

Learn more about our low personal loan interest rates and flexible repayment options by visiting the Tata Capital website or downloading the app.

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FAQs

What are penal charges in OD?

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.

How to calculate penal charges?

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.

How to avoid penal charges?

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.

How much are penal charges?

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

What is the difference between penal charges and penal interest in loans?

When you are unable to pay the loan or delay EMI payments, a fixed fee is levied. It is known as penal charges. Penal interest is extra interest added to the overdue amount for a specific period. Penal interest calculation is done as a percentage.

How do banks calculate penal charges for late EMI or overdue payment?

Banks calculate penal charges based on loan terms. It may be a fixed amount or a percentage of the overdue EMI. Penal charges are applied after the due date until payment is made.

Are penal charges legal in India, and what does the RBI say?

Yes, penal charges are legal in India. The RBI allows them, but directs banks to keep charges reasonable and transparent. Banks must not treat them as an additional interest burden on borrowers.

What types of fees are considered penal charges by Indian banks?

Penal charges include late EMI fees, cheque bounce charges, ECS or NACH failure charges, loan agreement violation fees, and penalties for delayed document submission or misuse of loan funds.

How can I appeal or request a waiver of penal charges as a borrower?

You can request a waiver by contacting the bank and explaining your reason for the delay. A good repayment history, genuine struggles, or first-time default improves your chances of approval.

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