What is Penal Interest?

When you take a loan, timely repayment is key. But what happens if you miss a payment or delay an EMI? That’s where penal interest comes into play. At My Mudra, we believe that knowing penal interest is important in order to manage your loans intelligently and save yourself from additional expenses. Let's get deep into what penal interest is, how it is calculated, and why it is important for all borrowers.

What Is Penal Interest?

It is an additional cost that lenders charge if you don't pay your EMIs or loan instalments on time. Alternately referred to as penalty interest or default interest. So, it's a penalty – an extra interest rate levied on the overdue amount for the duration you don't make a payment. It is above the regular rate of interest on your loan.

Think of it like a late fee. Rather than a flat penalty, penal interest is calculated as a percentage of the amount you owe, and it continues to accumulate the longer you put it off. It’s designed to incentivise responsible borrowing and timely payments. The penal interest rate is typically higher than your standard loan interest rate, making late payments costly.

Penal Charges vs. Penal Interest

You might hear the terms penal interest and penal charges used synonymously, but they’re not exactly the same:

• Penal Interest Rate: This is the additional rate of interest charged on your overdue amount for the period of delay. It increases over time, increasing your outstanding balance.
• Penal Charges: These are fixed fees or penalties imposed for violations of loan terms, such as late payment fees or processing fees for delayed documentation. Unlike penal interest, these are one-time charges and do not accumulate. These fees are in addition to interest and do not themselves accrue interest.

Both penal interest and penal charges act as deterrents to defaults; however, penal interest compounds over time and thus becomes more expensive, whereas penal charges are fixed one-time penalties.

How does Penal Rate of Interest Differ from Regular Interest Rate?

The penal rate of interest is the specific interest rate applied to calculate penal interest. It is typically expressed on a per annum basis but applied monthly or daily depending on the lender’s terms. 

For instance, if your normal loan interest rate is 12% annually. The penal interest rate could be 18% per annum or more. However, it is worth noting that an increased rate is charged only on the overdue amount for the period of delay.

Why Do Lenders Charge Penal Interest?

You might wonder – why do lenders charge penal interest at all? The answer lies in risk and fairness. Lenders face risks and costs when borrowers delay payments. Charging penal interest helps them in the following ways –

• Compensating for Risk: When you delay your payment, the lender faces increased credit risk. 
• Administrative Expenses: Handling overdue accounts requires extra effort, including sending reminders, follow-ups, and, in some cases, legal action.
• Promoting Discipline: Penal interest motivates borrowers to pay on time, maintaining smooth cash flow for lenders and financial discipline for borrowers.

As per RBI guidelines, penal interest and penal charges rates must be reasonable as well as transparent so that borrowers are not exploited through unfair practices.

Penal Interest Calculation Made Simple

Calculating penal interest might sound tricky, but it’s straightforward once you know the formula. It depends on three things:

• The overdue amount (missed EMI)
• The penal interest rate
• The duration of the delay

Basic Formula for Penal Interest

• Daily basis:
  Penal Interest = Overdue Amount × (Penal Interest Rate / 365) × Number of Days Delayed
• Monthly basis:
  Penal Interest = Overdue Amount × (Penal Interest Rate / 12) × Number of Months Delayed

Example 1:

Suppose you have an overdue EMI of ₹50,000 delayed by one month, and the penal interest rate is 24% p.a.

• Monthly penal interest = 50,000 × (24% / 12) = 50,000 × 2% = ₹1,000

Therefore, you have to pay an additional ₹1,000 as penal interest for that one month’s delay.

Example 2:

If you delay ₹20,000 for 3 months with a penal interest rate of 2% per month:

• Monthly penal interest = ₹20,000 × 2% = ₹400
• Total penal interest for 3 months = ₹400 × 3 = ₹1,200

This shows how quickly penal interest can add up, especially for longer delays.

Penal Charges in Loan Accounts

Besides penal interest, lenders may also impose penal charges. Penal charges are fixed fees for breaches of loan terms other than late payments. For example:

• Missing document submission deadlines
• Violating financial covenants
• Failing to create security interest on time
• Prepayment penalties (in some cases)

Unlike penal interest, penal charges:

• Are fixed amounts, not percentages
• Do not attract further interest (no compounding)
• Are imposed as per RBI’s fair lending guidelines

These charges are often smaller but can add up if multiple penalties apply.

The Real Impact of Penal Interest on Your Loan

Penal interest might seem like a small extra fee, but it can significantly increase your loan burden if ignored. Here’s how it affects you:

• Increased Loan Cost: Your total repayment amount goes up, sometimes substantially.
• Higher EMIs: If penal interest is added to your outstanding principal, your EMIs may increase.
• Credit Score Damage: Persistent late payments and penal interest can hurt your credit score, making future loans harder or costlier.
• Legal Consequences: Long-term defaults can lead to legal action and asset seizure in secured loans.

Tips to Avoid Penal Interest and Charges

Avoiding penal interest is simpler than paying it. Here’s how you can stay penalty-free:

• Set Payment Reminders: Use phone alarms or calendar alerts.
• Automate EMIs: Link your bank account for automatic deductions.
• Maintain a Buffer: Keep some extra funds to avoid missed payments.
• Communicate Early: If you anticipate delays, inform your lender. Some may offer grace periods or restructuring.
• Understand Your Loan Agreement: Know the penal interest rate and charges before signing.

How My Mudra Helps You Manage Loans and Avoid Penal Interest?

At My Mudra, we offer transparent personal loans online with clear terms and competitive interest rates. We encourage borrowers to read and understand their loan agreements carefully. So, when they go through every detail, they will also understand the penal interest clauses.

Our easy repayment options and regular reminders enable you to track your EMIs, minimising the risk of penal interest charges.

Wrapping Up

Penal interest is a fine imposed on delayed loan payments, calculated as extra interest rate on the delayed amount. It differs from penal charges, which are fixed fees for other breaches of loan terms. Knowing what penal interest is and how penal interest calculation works can save you from unexpected costs and help maintain a healthy credit profile.

Remember, timely payments are the best way to avoid penal interest and keep your loan journey smooth.