At Capital Mind I have been strongly in favour of abolishing any sort of prepayment penalty. (Read: The Unnecessary Prepayment Penalty, written in 2011) The RBI had, in 2012, banned prepayment penalties on home loans.

Now, they’ve banned it on all sorts of floating rate loans. This will include any loans that you take for a fixed term, but at a floating rate. But this applies only to individuals (not corporates or trusts).

This is good for floating rate term borrowers of, for instance, education loans. They can now prepay without a penalty. Or for any other such loan.

The idea is that having a prepayment penalty restricts customers from shifting to cheaper funding opportunities; banks, though, have little risk because if their rates were to go up, the loan itself would pay more because it is a floating rate loan.

The restriction therefore reduces “discovery”. Without a prepayment penalty, the market will be incentivized to find the cheapest lender, so that everyone will fight to go to that rate – and therefore banks will “transmit” appropriate interest rates to customers.

Note: Most car loans are fixed term, fixed rate. Term loans of the “personal loan” variety too are fixed. These won’t benefit.

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