RBI prohibits Pre-Payment Charges on Floating Rate Loans

In a move set to significantly ease credit terms for borrowers, the Reserve Bank of India (RBI) has issued a new set of comprehensive guidelines prohibiting prepayment charges on floating rate loans taken by individuals and Micro and Small Enterprises (MSEs). The Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 (the “Directions”) will be enforced on all loans and advances sanctioned or renewed on or after January 1, 2026.

The Directions were introduced to address inconsistent practices among regulated entities (REs), including banks and NBFCs, which often imposed prepayment charges that acted as a deterrent to loan foreclosure and refinancing. The RBI noted that such practices resulted in customer grievances, reduced credit mobility, and sometimes included restrictive clauses in loan agreements discouraging borrowers from switching lenders.

The new framework builds upon the RBI’s earlier guidelines (issued in 2012 via Circular bearing Reference No. RBI/2011-12589 DBOD.NO.Dir.BC.107/13.03.00/2011-12 dated June 5, 2012 and 2014 via Circular bearing Reference No. RBI/2013-14/582 DBOD.Dir.BC.NO.110/13.03.00/2013-14 dated May 7, 2014), which barred prepayment charges on floating-rate home and personal loans but now extends the relief to business-purpose loans availed by individuals and MSEs.

The directions follow a public consultation process initiated through a draft circular released in February 2025 and are part of the developmental agenda announced by the RBI in October 2024.

• Individuals (Non-Business Purpose): All regulated entities (REs) are barred from charging prepayment penalties on floating-rate loans taken by individuals for non-business purposes regardless of co-obligants, source of repayment, or loan amount. This includes housing loans, education loans, and personal loans.

• For business-purpose loans to individuals and MSEs:

1. No charges are allowed when loans are provided by:
   • Commercial banks (excluding Small Finance Banks, Regional Rural Banks, and Local Area Banks);
   • Tier 4 Urban Co-operative Banks;
   • NBFCs–Upper Layer (NBFC-UL);
   • All India Financial Institutions.
2. No charges can be levied on loans up to ₹50 lakh by:
   • Small Finance Banks (SFBs);
   • Regional Rural Banks (RRBs);
   • Tier 3 Urban Co-operative Banks;
   • State and Central Co-operative Banks;
   • NBFCs–Middle Layer (NBFC-ML).

These exemptions apply irrespective of whether the prepayment is in part or full, regardless of the source of funds used, and without any minimum lock-in period.

• Special Rate Loans: For dual or hybrid rate loans (combination of fixed and floating), prepayment charge exemption applies if the loan is on a floating rate at the time of prepayment.
• Clarifications for Cash Credit and Overdraft Accounts: Prepayment charges shall not apply if the borrower informs the lender in advance about the decision not to renew the facility and ensures that it is closed on the due date. If charged, prepayment fees for such accounts must be calculated only on the sanctioned limit, not the outstanding balance.
• Transparency and Disclosure Mandates:

1. • All applicable prepayment terms must be clearly stated in the loan sanction letter, loan agreement, and, where applicable, the Key Facts Statement (KFS) as per RBI’s April 2024 guidelines.
   • No undisclosed, retrospective, or previously waived charges can be reinstated or levied at the time of prepayment.
   • No charges can be levied if the prepayment is initiated by the lender itself, such as in restructuring scenarios or where the borrower is asked to exit.
   • Capitalization of unpaid charges not envisaged under these Directions at the time of prepayment is prohibited.

For loans that fall outside the exemption categories, such as fixed-rate loans, foreign currency loans, or structured commercial credit, regulated entities may impose prepayment fees, provided:

• The charges are reasonable.
• In line with the lender’s Board-approved policy, and
• Disclosed upfront to the borrower.

These directions apply to all commercial banks (excluding Payments Banks), Co-operative Banks, NBFCs, and All India Financial Institutions.

The RBI’s directions mark a pivotal step in promoting fair lending practices, borrower mobility, and consumer protection especially for individuals and India’s thriving MSE sector.