Furthermore, under the new guidelines, loan sanction letters will need to mention the costs associated with transitioning from a floating to a fixed interest rate in the future. Lenders will be required to ensure that even in the event of significant rate hikes, the EMIs will continue to cover the monthly interest payments, preventing any increase in the outstanding loan balance from the previous month after the EMI is paid.
The RBI’s circular on resetting floating interest rates for EMI-based personal loans said that lenders should not solely assess repayment capacity based on prevailing interest rates but they should factor in a cushion to ensure borrowers can meet their payment obligations even if interest rates climb.In the past, interest rates have experienced fluctuations of up to six percentage points within a single loan cycle, which means the interest burden had sharply increased and typically the loan tenure rose by years. Lenders have sometimes refrained from adjusting EMIs, as extending the EMI duration would result in higher interest earnings.
The new regulations require lenders to evaluate repayment capacity at a rate higher than the prevailing one.
Presently, banks determine borrowers’ repayment capability using prevailing interest rates. For example, an individual with 20 years until retirement might afford a Rs 74,557 EMI for a Rs 1 crore loan at a 6.5% interest rate. However, at an 11% interest rate, their affordability might decrease to Rs 72 lakh.
Most banks currently don’t offer fixed-rate loans due to short-term deposit structures. A senior banker told ToI that if forced to provide fixed rates, banks would include a sufficient markup to mitigate interest rate risks.“Regulated entities are required to take into account the repayment capacity of borrowers to ensure that adequate headroom/ margin is available for elongation of tenor and/ or increase in EMI, in the scenario of a possible increase in the external benchmark rate during the tenor of the loan,” the RBI said.
RBI Governor Shaktikanta Das last week said that the central bank would review EMI norms to address concerns about banks unduly extending home loan tenures post interest rate hikes. He said that banks should evaluate appropriate tenures based on borrower payment capacities, considering age-related factors.
A senior private bank official told ET Online they have seen many cases where loan tenure extended beyond the usual life expectancy.
The new rules, effective December 31, 2023, apply to both new and existing borrowers. They enhance transparency by necessitating the disclosure of principal and interest recovered to date, remaining EMIs, EMI amounts, and the annualized rate of interest/Annual Percentage Rate (APR) for the entire loan duration.
Traditionally, lenders accounted for rising income and the cyclical nature of interest rates when evaluating borrower eligibility. However, in some sectors, incomes have not kept pace with inflation. Moreover, banks in the West are preparing for prolonged periods of elevated interest rates.
Given that home loans significantly drive credit growth, most lenders focus on this sector to expand their lending portfolios. To reach a wider audience, finance companies target the affordable housing segment, which includes many individuals new to credit and unfamiliar with the implications of rising rates.
The RBI clarified that these instructions will apply to all equated installment-based loans of different frequencies, in addition to equated monthly installment loans. This means that lenders must also tighten norms for loans against property and perhaps education loans, both of which fall into the category of loans with extended tenures.
(with inputs from ToI)