Penal Interest: Meaning & How It Is Calculated?

Irrespective of whether you are an individual or a business, before taking any kind of loan, you should have a solid repayment strategy in place. Delayed loan EMIs will not only impact your credit score but also result in penalties.For each of your delayed EMI, you will be required to pay a late payment fee in the form of penal interest. What is this penal interest? How is it calculated? Let us have a look-

The penal rate or penal interest is a type of penalty interest levied by the loan provider if a borrower does not pay the loan EMI as per the repayment schedule of the loan.
Irrespective of whether you pay monthly EMIs or make the payment quarterly or annually, if the lender does not receive the loan payment by the scheduled date, you will be required to pay penal interest on the same.

Lenders impose penal interest on overdue loan payments for several reasons:

• Compensating for Risk Late payments increase the lender’s risk, so penal interest serves as compensation.
• Encouraging Timely Payments The penalty discourages borrowers from delaying EMI payments, ensuring financial discipline.
• Covering Administrative Costs Managing overdue accounts requires additional effort and resources, which penal interest helps cover.
• Preventing Loan Defaults Hefty penalties act as a deterrent against prolonged defaults that can impact a lender’s financial health.
• Protecting Profitability Delays in payments affect cash flow, and penalties help mitigate potential revenue losses.
• Maintaining Credit Discipline Borrowers who consistently pay on time maintain a good credit score, whereas penal interest discourages irregularities.
• Regulatory Compliance Some lenders charge penal interest to align with regulatory frameworks and industry best practices.
• Compensating for Liquidity Constraints Late payments may force lenders to seek alternative funding sources, which could be costlier.

• Automate Your Payments Set up automatic EMI deductions to ensure timely payments.
• Maintain Sufficient Balance Ensure you have adequate funds in your bank account on EMI due dates.
• Use Reminders Set reminders or alerts to track EMI due dates and avoid missing payments.
• Opt for a Flexible Tenure Choose a loan tenure that aligns with your repayment capacity.
• Communicate with Your Lender If facing financial difficulties, negotiate with the lender for an extension or restructuring of EMIs.
• Pay EMIs in Advance If possible, pay a few days earlier to avoid any last-minute transaction issues.
• Monitor Loan Terms Be aware of the penal interest rates and repayment clauses mentioned in the loan agreement.

The penalty rate varies between different lenders. If you have taken an SME loan , the penal interest fixed by the lender would be over and above the applicable interest rate of the loan.The penal interest rate of the lender, overdue amount, and period of default is taken into consideration for penal interest calculation .

The penal interest is generally mentioned on per annum basis. For instance, if the penal interest of a lender is 24% p.a., it means that a penalty of 2% would be applicable to the overdue amount for every month of default.For instance, let us assume that you have a loan and EMI is Rs. 50,000 which is delayed by a month. If the penal interest is 24% p.a., the late payment penalty will be around Rs. 1,000 (2% of Rs. 50,000).

Yes, in 2018, the GST-AAR (GST Authority for Advance Rulings) imposed a GST of 18% on delayed loan payments. Once the penal interest amount is calculated as per the overdue amount and duration, GST would be applicable on this amount.So, in the example mentioned above, the penalty will be Rs. 1,180 when GST would be applied at the rate of 18%.

The high SME loans penalty rates levied by the lenders help them reduce the chances of defaults. If you are looking for a business loan , work on a repayment plan first so that you are not required to pay any late payment charges.While discussing your loan with the lender, do talk about the penal interest in detail to avoid any kind of discrepancies in the future.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.