The Reserve Bank of India (RBI) has introduced a fresh framework for loans with floating interest rates, aiming to enhance clarity and adaptability for borrowers. The key aspects of this novel framework are as follows:
Enhanced transparency
Lenders will be mandated to transparently convey the terms and conditions for resetting interest rates to borrowers. This encompasses detailing the chosen interest rate calculation index, the margin to be added to the index, and the frequency of interest rate adjustments. By doing so, borrowers will gain a deeper understanding of their loan arrangements, empowering them to make well-informed choices regarding repayment strategies.
Option for fixed interest rate conversion
Borrowers will have the flexibility to convert their loan to a fixed interest rate structure at their discretion, subject to specific conditions. This provision serves to alleviate the impact of rising interest rates on borrowers.
Loan prepayment flexibility
Borrowers will be granted the liberty to prepay their loans at any point, contingent upon certain applicable charges. This offers borrowers heightened adaptability, particularly in scenarios where property sales or opportunities for better interest rates emerge.
The introduction of this new framework by the RBI is positively received and is expected to provide valuable relief to individuals with loans featuring floating interest rates. Notably, it is imperative to recognize that the framework is currently in its nascent stage, with final particulars yet to be unveiled. However, the RBI has affirmed that the framework will be implemented within the upcoming months.
In unveiling the MPC's resolutions, Das conveyed, “It is proposed to put in place a transparent framework for reset of interest rates on floating interest loans.”
Need for a new framework in place
In the upcoming implementation of the new framework, lenders will be obligated to offer transparent communication to borrowers concerning the loan duration and equated monthly installment (EMI) details.
“The framework will require regulated entities to (i) clearly communicate with borrowers for resetting the tenor and/or EMI; (ii) provide options for switching to fixed-rate loans or foreclosure of loans; (iii) disclose various charges incidental to the exercise of the options; and (iv) ensure proper communication of key information to borrowers. The supervisory reviews undertaken by the Reserve Bank and the feedback and references from members of the public have revealed several instances of unreasonable elongation of the tenure of floating rate loans by lenders without proper consent and communication to the borrowers,” added Das.
When evaluating loan eligibility, banks will take into account borrowers' ability to make payments and their age. The framework is structured to offer a comprehensive perspective of borrowers' financial circumstances and to discourage extended loan durations.
Das also mentioned that the implementation of a novel framework for loans with floating interest rates will offer the central bank a more comprehensive understanding of the financial well-being of lending institutions.
Back in October 2019, the RBI stipulated that all loans tied to floating rates must be linked to an external benchmark. When this external benchmark system was initially introduced, banks were permitted to reset EMIs every quarter.
At present, borrowers have the option to transition between floating and fixed interest rates, albeit with a nominal conversion fee ranging from 0.50 per cent to two per cent of the total home loan amount.
Benefit of a transparent framework to reset loan interest rates
Under the upcoming framework, lenders will have the responsibility to transparently communicate with borrowers regarding the loan's duration, EMI details, and the choice to shift to a fixed interest rate. Furthermore, borrowers will retain the ability to prepay their loans at any time, contingent upon specific conditions.
The RBI holds the view that this fresh framework will furnish borrowers with heightened transparency and adaptability, thereby serving as a safeguard against the impact of ascending interest rates.
Prospective borrowers tend to favour fixed home loan interest rates due to the instability and variability associated with floating rates, which are contingent upon market conditions.
Floating rates are influenced by the underlying base rate of banks. Consequently, whenever there is an alteration in the base rate, the interest rate is automatically adjusted accordingly. As a result, any adjustments made by the RBI to its repo rate are transmitted to borrowers.
