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Penal Interest

Updated on October 4, 2023

The primary condition of taking a loan is to repay the same within the loan tenure and in regular EMIs. However, if the borrower is unable to repay the same in due time, they are liable to pay a penalty on the loan amount in the form of penal interest. Given here is the meaning of penal interest in loans and related details.

Meaning of penal interest

Penal interest, often referred to as “penalty interest,” is an additional amount of interest charged by a lender or financial institution when a borrower fails to make timely repayments on a loan or credit facility. It is essentially a financial penalty imposed on the borrower for not adhering to the agreed-upon loan repayment schedule. The Reserve Bank of India (RBI) has issued guidelines that regulate the imposition of penal interest by banks and financial institutions. These guidelines specify the maximum penal interest rates that can be charged, and they are usually capped to prevent lenders from imposing exorbitant penalties. The addition of penal interest can also damage the credit score of the borrower and impact their ability to get loans.

What is the purpose of levying penal interest?

The primary purpose of penal interest is to incentivize borrowers to make their loan payments on time. It serves as a financial penalty for the inconvenience and added administrative costs that late payments can cause the lender. Penal interest also helps lenders recover some of the potential losses incurred due to delayed payments.

How to avoid penal interest on loans?

To avoid incurring penal interest on loans, it is crucial to consistently adhere to the loan repayment schedule and ensure that payments are made on or before the due date. Timely payments are the most effective way to prevent additional charges. If you foresee difficulties in making a payment, proactively communicate with your lender to explore possible solutions, such as loan restructuring or deferment, which can help you avoid late fees and penalties.