Penal interest is a type of additional interest lenders charge on outstanding loan balances when borrowers fail to make timely payments or default on their loan obligations. It is a punishment for the borrower’s failure to fulfill their loan repayment obligations on time. The imposition of penal interest is common among lenders to incentivize borrowers to make timely payments and compensate the lender for the additional risk and cost associated with late or non-payment.
The lender determines penal interest rates usually specified in the loan agreement. The penal interest rate varies among lenders, ranging from 1% to 5% of the monthly overdue amount.
The imposition of penal interest is common among lenders to incentivize borrowers to make timely payments and compensate the lender for the additional risk and cost associated with late or non-payment. Penal interest rates are generally higher than the standard interest rates charged on loans and can significantly impact the borrower’s overall loan repayment amount.
How is penal interest calculated?
The lender determines penal interest rates and is usually specified in the loan agreement. The penal interest rate varies among lenders, ranging from 1% to 5% of the monthly overdue amount.
For example, suppose a borrower has an outstanding loan balance of Rs.1,00,000/-, and the monthly penal interest rate is Rs.2,000/- per month as penal interest until the due amount is paid.
The calculation of penal interest is usually based on the number of days of delay or non-payment. Depending on the loan agreement, the lender may charge a daily or monthly penal interest rate.
For instance, if the loan agreement specifies a monthly penal interest rate of 2%, the borrower will be charged a penal interest of 2% on the outstanding loan amount for each month of delay or non-payment.
When is penal interest charged?
Penal interest is usually charged when borrowers fail to make timely loan payments or default on their loan obligations. The exact timing of the imposition of penal interest varies depending on the lender and the loan agreement.
In some cases, penal interest may be charged immediately after the due date of the loan payment, while in other cases, there may be a grace period before penal interest is charged.
It’s important to note that penal interest is typically charged in addition to other fees associated with late or non-payment, such as late payment fees, legal fees, and collection charges.
How does penal interest affect borrowers?
The imposition of penal interest can significantly impact borrowers’ financial and credit scores.
Financial Impact:
The additional interest charges can significantly increase the overall cost of the loan for the borrower. The longer the delay in loan repayment, the higher the penal interest charges will be, resulting in a higher overall loan repayment amount.
For instance, if a borrower has an outstanding loan balance of Rs.1,00,000/- and the standard interest rate on loan is 10%, the borrower will be required to pay an interest of Rs.10,000/- annually. However, suppose the borrower defaults on their loan obligations, and penal interest of 2% per month is charged. In that case, the borrower will be required to pay an additional Rs.2,000/- monthly interest charges, resulting in higher total interest charges than decided at the time of sanction.
In addition, if the borrower continues to default on their loan payments, the outstanding balance will accumulate disciplinary interest charges, making it even more difficult for the borrower to repay the loan.
Credit Score Impact:
Penal interest charges can also harm the borrower’s credit score. Late or non-payment of loans can result in a lower credit score, making it more difficult for the borrower to obtain credit in the future.
Late or non-payment of loans can also result in the lender reporting the borrower’s default to credit bureaus, which can have a long-term impact on the borrower’s credit history and credit score.
In addition, if the borrower defaults on their loan obligations and the lender take legal action to recover the outstanding loan balance, it can further damage the borrower’s credit score and financial reputation.
How can borrowers avoid penal interest?
Borrowers can avoid being charged penal interest by making timely loan payments and fulfilling their loan obligations. This can be achieved by setting up automatic payment systems or reminders to ensure that loan payments are made on time.
If a borrower cannot make a loan payment on time, it’s essential to communicate with the lender and explain the situation. The lender may be willing to provide a grace period or offer alternative payment arrangements to avoid the imposition of penal interest charges.
In addition, borrowers should carefully review the loan agreement to understand the terms and conditions, including the penalties for late or non-payment. Borrowers should also consider the total cost of the loan, including any additional charges, before agreeing to the loan.