Penal Interest: Meaning, Definition & How It Is Calculated

Whether you are a self-employed or salaried individual looking for a loan, you must plan a solid strategy to repay the borrowed amount on time. Most loan providers have flexible repayment terms, allowing you to choose a tenure with budget-friendly EMIs. However, if you delay the EMI payments, it impacts your credit score and attracts penal interest. It is a penalty you must pay for missing your EMI payments. In the following sections, you will understand the penal interest meaning on instant Personal Loans.

What is Penal Interest?

Penal interest is a penalty a loan company charges if you do not pay your loan EMIs on time as agreed in the repayment schedule. Whether you pay your EMIs monthly, quarterly, or annually, the lender will charge a penal interest on the same if you do not pay them by the due date.

Some loan providers also charge the penalty on prepayment, regulatory non-compliance, and breach of the EMI repayment schedule. Enquire about the penalty before signing the loan contract, as it may vary between lenders. Since the RBI requires the penal charges to be transparent and fair, the loan agreement should mention them clearly.

How is The Penal Interest Calculated?

Lenders charge penal interest as a small percentage of the per annum interest over and above the pre-determined interest rate. As a borrower, you must pay this amount in addition to the actual loan cost to be paid during a period.

Loan providers calculate the penal interest on the due amount rather than the post-maturity applicable interest. If the loan term is more than 12 months, they calculate the penalty on the compound interest rate.

Just like knowing the calculation of Personal Loan interest is crucial, knowing how a penal interest is calculated is equally essential.

Penal interest is charged on non-payment of instalments on the overdue amount. It is usually calculated on a per annum basis. For example, if the penal interest of a lender is 24% p.a., a penalty of 2% would be charged to the overdue amount for every month of default.

Are Taxes Applicable On Penal Interest?

When a loan company lends a loan, it enters into an agreement with the borrower considering the repayment terms. They compute the loan instalments based on the loan amount, interest rate, and tenure. Generally, you must repay a fixed amount of EMI to the lender at a certain date each month. Each EMI includes the interest and the principal amount.

If you delay the EMI repayment, the lender charges penal interest on the due amount for the delayed days using a penal interest calculation formula. According to the exemption granted through Serial No. 27 of Notification No. 12, the additional interest is meant to tolerate the act of customers and is covered by Schedule II, CGST Act, 2017. That means that the penal interest falls under an exemption and is non-taxable.

The Perils Of Loan Default

Loan default is when you fail to repay the principal and interest amount to the lender. Any borrower can default on a loan repayment under financially challenging situations. The perils of loan default might include the following:

• When you default, your lender may sue you to recoup the funds.

• If you borrowed a secured loan and pledged property as collateral, the lender may seize it and sell it to recover their funds. On the other hand, instant Personal Loans being unsecured do not pose a threat to your property.

• Negative remarks on your credit report

• Reduced credit score

• Difficulty getting credit in the future

• Higher interest rates on new debt

• Small loan amounts and shorter loan terms for future loans

Dos and Don’ts of Penal Charges

Here are a few do’s and don’ts of penal charges you must be aware of:

Do’s:

• Before applying for secured loans or instant Personal Loans, enquire about the applicable penal charges. Financial situations may change, and you would not want to fall into a debt circle due to a hefty penal interest. Knowing them beforehand keeps you prepared for the unexpected.

• Always make a robust repayment plan to avoid paying penal charges. Prioritise your loan repayment, set reminders, and automate e-mandate to pay EMIs on time without defaulting.

• Read the loan agreement to know the penal charges and ensure they are reasonable and transparent.

Don’ts:

• The penal charges should be in the form of a charge and not an additional interest levied on the current interest. The lender should charge it separately only if you default on the EMI payment.

• According to the RBI guidelines, the lender cannot recover any other interest or penal charge from the borrower.

• The lender should not treat penal charges as a source of capitalisation. It is a way to discourage borrowers from defaulting. It is not an additional source of income for the lender.

Conclusion

Now that you know what penal interest is, make a solid repayment plan before applying for a loan. If you need an instant Personal Loan, apply online on the Hero FinCorp website or mobile app after calculating your EMIs and total interest using a Personal Loan Calculator. This will help you keep your repayment manageable and avoid penal charges.

FAQ:

Is the penal interest taxable?

No, it was taxable earlier. However, according to the latest guidelines, penal interest is non-taxable.

Is GST chargeable on penal interest?

No, penal charges are not GST chargeable. According to the exemption granted through Serial No. 27 of Notification No. 12, the additional interest is only meant to tolerate the act of customers. It is covered by Schedule II, CGST Act, 2017.

What is the penal fee?

Penal fee is the additional charge you must pay to the lender if you miss an EMI payment during the loan term. The penal charges differ between lending institutions based on their internal policies and RBI guidelines.

What is the difference between interest and penal interest?

Interest is the fee the lender charges from the borrower to offer them the required funding. Penal interest is an additional charge they recover from the borrower if they miss paying their EMI payments on time.