Regulations on Interest Rate Resets on EMI based personal loans explained

The Reserve Bank of India (RBI) defines a personal loan as a type of unsecured credit that individuals can obtain from financial institutions. Personal loans can be used for various purposes, including debt consolidation and moving expenses. These loans are repaid in installments, or regular payments, over a specified period.

Key Characteristics of Personal Loans

• Unsecured Nature: Personal loans do not require collateral such as property, bonds, or fixed deposits.
• Flexibility: Borrowers can use the funds at their discretion for diverse financial needs.
• Regulatory Oversight: The RBI mandates transparency in interest rates and fair lending practices.

Communication of Interest Rate Resets

The RBI has advised regulated entities (REs) to communicate the impact of interest rate resets on floating-rate personal loans to borrowers at the time of loan sanction and throughout the loan tenure. The communication should cover the following aspects:

Frequency and Content of Communication

1. When to Communicate:
   1. At the time of loan sanction.
   1. During the loan tenure whenever there is a change in the interest rate.
2. Content of Communication:
   1. Notification of interest rate changes.
   1. Options available to borrowers to manage increased EMIs.
   1. Implications on loan tenure and total interest outgo.

Options Available to Borrowers

In accordance with existing regulations, banks and financial institutions must inform borrowers of the options available to address increases in EMIs during a rising interest rate scenario. The options include:

1. Adjustment of EMI or Loan Tenure:
   1. Increase in EMI amount while keeping the tenure unchanged.
   1. Extension of loan tenure while maintaining the current EMI amount.
   1. A combination of both options.
2. Conversion to Fixed Interest Rate:
   1. Borrowers may switch to a fixed interest rate for the remaining loan tenure.
   1. If the RE does not currently offer fixed interest rate products in a specific loan category, it is not mandatory to introduce them. However, flexibility must be provided for switching, subject to applicable charges.
3. Prepayment Options:
   1. Borrowers may prepay the loan, either partially or in full, at any time during the remaining loan tenure.
4. Switching Between Floating and Fixed Rates:
   1. Borrowers can switch between floating and fixed interest rates as per the RE’s Board-approved policy.
   1. The RE must specify the number of times a borrower is allowed to exercise the switch option.

Applicability Across Loan Categories

The RBI has clarified that the provisions of the circular apply to all equated installment-based personal loans, irrespective of whether they are linked to an external or internal benchmark.

Disclosure Requirements

During the loan tenure, any increase in EMI or loan tenure due to changes in the external benchmark rate must be communicated to borrowers. Additionally, REs are required to provide quarterly statements that include:

• Principal and interest recovered to date.
• Current EMI amount.
• Number of EMIs remaining.
• Annualized rate of interest applicable for the remaining tenure.

Special Provisions for Housing Loans

The options specified in the RBI’s circular dated August 18, 2023, regarding the reset of floating interest rates shall also apply to housing loans provided by Urban Cooperative Banks (UCBs), subject to compliance with the regulations outlined in the Master Circular on Housing Finance for UCBs dated April 11, 2023, or as amended in the future.

By implementing these measures, the RBI aims to ensure borrower awareness, financial planning flexibility, and enhanced transparency in the management of personal loans.