Banks to tighten home loan approvals, EMIs may go up under RBIs new rule

For most people, personal loans and home loans are convenient ways to fulfil their financial needs like going for higher education or buying a house. First-time borrowers may feel daunted by the prospect of increasing interest rates. Loan interest rates might soon see a change after the Reserve Bank of India’s recent circular. The lenders may tighten approval for loans and increase equated monthly instalments (EMIs) on some tenures after the RBI’s latest circular, issued last month.

What does the RBI’s latest circular state about floating interest rate loans?

In its notification titled ‘Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans’, issued on August 18, RBI has asked lenders to take into account the repayment capacity of borrowers at the time of approving floating rate personal loans. Regulated entities (RE) should ensure that adequate margin is available for revising the tenure of the loan to a longer one and/or increase in EMI, if external benchmark rate increases during the loan term.

Borrowers will be given the option to switch over to a fixed interest rate instead of floating rate at the time of the interest rate reset. The policy must also specify how many times the interest rate regime can be changed. The letter at the time of loan approval must clearly mention any charges that will be levied on switch of interest rate regime, according to the RBI circular.

Two options will be given to borrowers with floating interest rate loans. They can either increase their tenure or their EMIs at any point during the loan term. A combination of the two options can also be availed. Borrowers will be able to prepay their loan in part or in full at any point in the tenure. The lender should ensure that any increase in EMI or tenure should not lead to negative amortisation, meaning that the amount owed goes up despite payments because the individual is not able to cover the interest.

What are the effects of the new notification by the RBI?

The new rules were issued by the RBI after the bank regulator received multiple grievances from floating interest rate borrowers. The lenders have time until December 31, 2023, to extend the instructions to both new and existing borrowers. The scrutiny by lenders may make it difficult for new borrowers to avail floating interest rate loans if they do not have proper repayment capacity.

On their part, banks will have to clearly communicate any changes in policy, charges, and consequences of change in EMI/tenure. The lenders must ensure that the RBI’s instructions apply to all EMI-based loans of different periodicities. The lenders must have adequate information systems in place to monitor changes in the benchmark rate to the lending rate. This will make customers more aware about any alterations in their policy and how much they have to pay.