What is Penal Interest?
What is penal rate of interest? Simply put,penal interest is a fee added when you do not repay your personal loan on the agreed date. It is not part of your regular loan charges. RBI needs penal charges to be fair, so your loan agreement must mention it clearly.
Penal interest meaning explains this charge as a way to keep loan repayment habits strong. The cost depends on the terms mentioned during approval. It shows how it stays higher than the usual personal loan interest rate. It keeps your loan on track and helps the lending system stay fair, fast, and secure for everyone.
Why do Lenders Charge Penal Interest?
1. Late Payments - Missing the payment date creates issues for the lender. Penal interest helps cover the cost of delays and reminds the borrower to repay on time in the future.
2. Loan Defaults -If someone fails to repay completely, it affects the lender’s trust. This charge adds pressure on the borrower to clear dues and follow the agreement without delay.
3. Financial Discipline -Timely payments keep the loan process fair. Adding this charge supports honest repayment behaviour and protects both sides from sudden risks or loss.
4. Operational Costs -When payments are delayed, tracking and follow-ups increase. This charge helps manage extra effort and keeps the loan system smooth.
Check out lendingplate’s Personal Loan Terms and Rates !
Difference Between Regular Interest and Penal Interest
Parameter | Regular Interest | Penal Interest |
Meaning | Charged for borrowing money as per the loan plan shared at the time of approval. | Extra charge added when repayment is missed or delayed beyond the set due date. |
Objective | To earn a return on the money lent to the borrower under agreed terms. | To control delay, avoid loss, and make sure the borrower pays dues on time. |
Applicability | Applied from the start till the loan is fully paid within the agreed schedule. | Applied only when the borrower fails to repay the instalment on time. |
Calculation | Based on the principal loan amount and tenure fixed at the start of the loan. | Based on the overdue amount and the number of delayed days after the due date is missed. |
Interest Rate | Lower and fixed as per the agreement shared at the time of approval. | Higher than the base interest rate and mentioned in the repayment terms clearly. |
Impact on Borrower | Keeps the repayment steady with no added charges if paid as scheduled. | Increases the total repayment amount when dues are not cleared on time by the borrower. |
How is Penal Interest Calculated?
Now you know what is penal interest. Penal interest is usually added to the overdue loan amount for the days the payment is late.
Here’s an explanation:
First, Identify the Overdue Amount
Check the EMI or part of the loan that is still unpaid after the due date.
Second, Know the Penal Interest Rate
This rate is mentioned in your loan agreement and is charged over the normal interest rate.
Third, Calculate for the Overdue Period
Monthly Calculation -
If charged monthly, use:
Penal Interest = [Overdue Amount] × [Penal Rate (%)] ÷ 100 × [Months Overdue]
Daily Calculation -
If charged daily, use:
Penal Interest = [Overdue Amount] × [Penal Rate (%)] ÷ (100 × 365) × [Days Overdue]
These help borrowers see how penal interest is added if they pay late.
Example of Penal Interest Calculation
How to calculate penal interest? Suppose your overdue EMI is ₹15,000. The penal interest rate is 3% per month, and the delay is 2 months.
Overdue Amount: ₹15,000
Penal Interest Rate: 3% per month
Delay: 2 months
Penal Interest Calculation -
1. Monthly Penal Interest -
[Monthly Interest] = ₹15,000 × (3 ÷ 100)
= ₹15,000 × 0.03 = ₹450
2. Total Penal Interest for 2 Months -
[Total Penal Interest] = ₹450 × 2 = ₹900
What’s the Result?
The added penal interest will be ₹900 on the overdue EMI of ₹15,000 if the repayment is delayed by 2 months.
A Quick Note - Always read the loan terms, as the method and penal interest rate may change based on your agreement.
Impact of Penal Interest on Credit Score and Finances
Credit Scores:Late repayments result in additional charges & get reported to credit bureaus. It lowers your credit score while affecting your future chances of loan approvals.
Borrowing Power:Additional charges show lenders that you are not paying on time. It lowers their trust & impacts the chances of getting future loans. Penal interest rate adds to your loan cost and reduces how much more you can borrow.
Read more: CIBIL Score
Types of Penal Charges
Here are the types of penal charges that you may experience:
1. Late Fees:Charged when you miss the EMI due date. This is added to your account until payment is made.
2. Bounced EMI Charges:Added when your account has a low balance and the EMI fails. This covers reprocessing and system costs.
3. Cheque Bounce Penalties:Applied when your cheque does not clear. This also affects your credit history and adds extra collection charges.
4. Auto Debit Failure Charges:If your linked bank rejects auto debit, lenders charge a fee for the failed attempt and the process delay.
5. Mandate Return Fee:Charged when your bank does not approve the auto payment request. This includes follow-up and reattempt costs.
6. Prepayment Penalty:Sometimes added if you clear your personal loan before the time. It depends on the lender’s terms.
It is imperative for borrowers to discuss these penalties before signing the loan agreement.
Also Read: Personal Loan Processing Fees
Ways to Avoid Penal Interest
You can stay away from penal interest by following easy steps that help you repay your loan on time.
1. Auto-Debit Setup:Link your bank to the auto-debit so your EMI gets paid without delay. No additional charges are added later.
2. Payment Reminders:Set alerts on your phone or app to remind you before the due date & avoid missing EMI deadlines.
3. Keep Enough Balance:Always keep your account funded before EMI dates. This stops failed payments and prevents added penalty charges from your lender.
4. Track Loan Schedule:Check your EMI dates on the app regularly. Knowing your repayment plan keeps you safe from unexpected extra fees.
5. Use the App:Use the lendingplate app to view loan details and pay instantly. Since it is fast & simple, it reduces the risk of delay.
6. Avoid Unplanned Expenses:Plan spending wisely during loan repayment. It keeps your budget ready for EMIs and protects you from penalty charges.
Do’s and Don’ts of Penal Interest
Follow these simple practices to avoid penal interest and keep your loan repayment smooth and stress-free.
Do’s
1. Always check your EMI dates in advance and pay before the time to avoid extra fees and credit score impact
2. Read all loan terms carefully before applying, so you understand when the interest applies and how it is charged
3. Stay updated on your payments and track your outstanding dues in real time
Don’ts
1. Don’t ignore payment reminders or alerts sent by the lender, as missed EMIs can bring unwanted penalty charges
2. Don’t delay updates to your bank details if they have changed, as failed auto-debits can result in extra fees quickly
3. Don’t assume grace periods apply to all loans; always repay by the due date to avoid added penal interest
The Perils of Loan Default
Missing EMIs or failing to repay a loan can lead to serious problems that affect your financial life and future options.
1. Credit score drops sharply with each missed payment
2. You lose trust with future lenders quickly
3. Extra penal interest keeps adding to your dues
4. Loan recovery actions can start against you
5. You may face legal notices from the lender
6. The chances of new loans get very low
7. Stress and pressure grow with increasing unpaid balance
How Does the Law Protect the Borrowers?
Laws protect you from unfair penal interest practices. RBI says lenders can only charge on unpaid amounts, not the total loan. These charges must be clear, fair, and as per board-approved rules. Lenders cannot add extra interest on the penal interest already charged.
This stops an additional burden on the borrower. If your lender breaks these rules, you can raise a complaint with the RBI or legal bodies. The policy helps you stay safe from hidden costs or misuse.
Conclusion
Understanding penal interest helps you avoid extra charges and stay in control of your finances. Late payments not only increase your dues but also reduce your credit score & borrowing strength. All charges are shown before approval, so nothing comes as a surprise. Paying responsibly helps you build trust, enjoy smooth loans, and stay safe from penalties.
Frequently Asked Questions (FAQs)
Q.1 Is the penal interest taxable?
Yes, for lenders, penal interest is treated as taxable income under Indian tax laws. It must be added to their total income while filing returns.
Q.2. Is GST chargeable on penal interest?
No, GST is not charged on penal interest by banks and NBFCs. As per the latest rules, these charges are treated as part of the loan contract and not as a separate service.
Q.3. How does compound interest affect loans?
Compound interest adds interest to both the principal & the past interest. This increases your total repayment over time. If not controlled, it makes loans costlier and reduces affordability.
Q.4. What are the consequences of not paying penal interest?
Not paying the penal interest can result in higher overdue balances, more late charges, or a reduced credit score. It may also lead to collection actions or legal notices.
Q.5. Is penal interest legal in India?
As per RBI rules, lenders can charge only fixed penal charges for defaults (not interest). These charges must be clear, separate, and non-compounding.
Q.6. Can penal interest be waived or reduced?
In rare cases, lenders may reduce or waive penal interest if the borrower explains genuine reasons or financial trouble. This is not guaranteed.
Q.7. How can borrowers avoid incurring penal interest?
Pay EMIs on or before the due date. Set reminders, enable auto-debit, and track your repayment plan using the lendingplate app. Keep your account funded, and don’t skip payments.
