Can you change current loan from floating rate to fixed interest rate and vice versa? RBI issues guidelines
The Reserve Bank of India (RBI) has come out with a circular on FAQs clarifying doubts regarding resetting of floating interest rates on personal loans with equated monthly installments (EMIs). The FAQs, issued on January 10, will improve transparency, give borrowers more control, and bring more clarity to how lending institutions operate.
It is important to note that this circular applies exclusively to EMI-based personal loans and does not extend to other types of loans, such as business or commercial loans. Personal loans, as defined in the RBI’s earlier circular dated January 4, 2018, are covered under this provision. Let’s understand which categories of loans fall under personal loans as per the RBI definition.
What is a personal loan as per RBI?
As per the RBI’s circular dated January 4, 2018, “Personal loans refers to loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc).”
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What are fixed and floating interest-rate loans?
Fixed interest rate loans, as the name suggests, are loans where the interest rate remains unchanged throughout the loan tenure. This means your EMI (Equated Monthly Installment) will remain constant, which will provide stability in your monthly payments.
A floating interest rate, on the other hand, is an interest rate that fluctuates over time based on changes in a benchmark rate. The Reserve Bank of India (RBI) sets the repo rate, which serves as a key benchmark influencing floating interest rates on home loans.
What do RBI FAQs say about changing a loan from a floating rate to a fixed interest rate and vice versa?
FAQs have made it clear that regulated entities, such as banks, have to provide the loan borrower with the option of switching to/from a fixed rate as per the board-approved policy at the time of interest rate reset.
It is important to note that this RBI circular on FAQs about loan interest rate resetting will apply to the existing borrowers as well.
What does it mean for borrowers?
This means that when the RBI hikes the repo rate, you will have the option to switch from a floating to a fixed interest rate by paying certain charges to save on interest costs. Similarly, when the RBI cuts the repo rate, you can switch from a fixed to a floating interest rate regime to benefit from lower interest costs.
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Here are FAQs:
Q.1 Does the circular apply to all loan products or only to personal loans?
Ans: The circular is applicable to all equated periodic instalment-based personal loans only. The circular is not applicable to other types of loans.
Q.2 Regulated entities (REs) have been advised to communicate to the borrowers the impact of interest rate reset on EMI, in a floating rate personal loans, both at the time of sanction as well as during the tenure of the loan. In this context, when and at what frequency shall REs communicate with the borrower? What will be the content of the communication?
Ans: Communications to borrowers envisaged in the circular are:
(a) At the time of sanction:
Annualised rate of interest/ Annual Percentage Rate (APR), as applicable, shall be disclosed in the Key Fact Statement (KFS) and the loan agreement.
The possible impact of change in benchmark interest rate on the loan.
(b) During the tenure of the loan:
Subsequently, any increase in the EMI/tenor on account of the external benchmark rate shall be communicated; and
Quarterly statements shall be provided disclosing at the minimum, the principal and interest recovered till date, EMI amount, number of EMIs left and annualized rate of interest for the tenor of the loan.
Q.3 REs have been advised to intimate the different options available to address the increase in EMI in a rising interest rate scenario. What are the different options available to borrowers during a rising interest rate cycle in respect of equated installment-based personal loans?
Ans: Whenever there is a reset of interest rates for an entire class of borrowers in a particular loan category, say home loan, due to increase in the reference benchmark; the RE shall provide the following options to the borrowers:
Either enhancement in EMI or elongation of number of EMIs, keeping the EMI unchanged or a combination of both options;
Switch to fixed interest rate for the remaining portion of the loan; and
To prepay, either in part or in full, at any point during the residual tenor of the loan.
Q.4 One of the options allowed to the borrower vide paragraph 2(ii) of the circular is the option to switch from a floating interest rate loan to a fixed interest rate as per their Board approved policy. If the REs presently do not have any fixed interest rate product in any loan category, say home loan, then is it mandatory for the RE to introduce such a product?
Ans: Yes, REs have to mandatorily offer fixed interest rate product in all equated installment based personal loan categories. As stated in paragraph 2 (ii) of the circular, REs shall provide the option to the borrowers to switch over to a fixed rate as per their Board approved policy at the time of reset of interest rates.
Q.5 Once the customer has exercised option to switch over from floating interest rate loan to a fixed interest rate loan, as allowed vide paragraph 2(ii) of the circular, then is the RE required to give option to the borrower to again switch back to a floating rate loan?
Ans: Yes, the intent of the circular is to allow flexibility to the customer to switch from floating rate loan to fixed rate loan or vice versa subject to applicable charges. The RE is required to specify the number of times a borrower will be allowed to exercise the switch option during the tenor of the loan under its Board approved policy.
Q.6 Whether the circular intends to cover only those loans which are linked to external benchmarks or the loans linked to Internal benchmarks (Base Rate/MCLR/BPLR) also?
Ans: It is clarified that the circular covers all equated installment-based personal loans, irrespective of whether they are linked to an external benchmark or an internal benchmark.
Q.7 Whether the instructions in the circular allow REs to levy applicable charges for switching loan from a fixed interest rate to a floating interest rate and vice versa?
Ans: Yes, as stated in paragraph 2 (iv) of the circular, RE can levy applicable charges for switching of loans from floating to fixed rate or vice versa and/ or any other service charges/ administrative costs incidental to the exercise of the switchover options and the same shall be transparently disclosed in the sanction letter and also, at the time of revision of such charges/ costs by the RE.
The applicable charges shall be as approved by the board of the RE and shall be displayed on their website as per extant instructions.