FAQs on Pre-Payment Charges
-Team Finserv | finserv@vinodkothari.com
Pre-payment means paying-off a loan before its scheduled end date. Borrowers may choose to pre-pay when they have extra cash or find better loan terms from another lender. While this may help the borrowers reduce their overall interest cost or improve their loan terms, lenders have traditionally charged a fee for such early repayment. These pre-payment charges are meant to cover the lender’s loss of expected stream income. So, from the lender’s perspective, pre-payment charges help make up for this loss. However, from the borrower’s perspective, such charges can feel unfair, especially on floating-rate loans, where the interest rate can change over time based on market conditions. Floating-rate loans already give lenders the ability to revise rates charging a penalty for early repayment adds another burden for the borrower.
The supervisory reviews of RBI have indicated divergent practices amongst the regulated entities with regard to levy of pre-payment charges in case of loans sanctioned to MSEs which lead to customer grievances and disputes. Further, certain REs have been found to include restrictive clauses in loan contracts/ agreements to deter borrowers from switching over to another lender, either for availing lower rates of interest or better terms of service.
To address this, RBI in October 2024 in the Statement on Developmental and Regulatory Policies, proposed that the ambit of prohibition on levy of pre-payment charges on floating rate loans extended to individuals be expanded to also include MSE borrowers. Accordingly, a draft circular was released on February 21, 2025. Based on the comments received and supervisory findings, the final Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 have been issued on July 2, 2025 (‘Prepayment Directions’).
The Prepayment Directions consolidate the diverse practices and provisions on levy of prepayment charges for all lenders. This would ensure uniformity with regard to prepayment of various loans by borrowers of banks and NBFCs (including HFCs).[1]
We have analyzed and collated questions on the various nuances and impact of the Prepayment Directions for better understanding in the form of FAQs as listed hereinafter:
A.… Applicability and Conceptual Understanding:
1…. Who all are covered under the Prepayment Directions?
2…. When do these Directions come into force?
5…. Whether the provisions of Prepayment Directions are applicable to demand loans as well?
6…. Does the provision apply only in case of part pre-payment or foreclosure as well?
8…. If a loan moves from fixed to floating rate mid-tenure, which rules apply at closure?
10.. What is the difference between a fixed rate and floating rate interest loan?
B.… Regulatory requirements in case of floating rate loan:
19.. What is the applicability of the Prepayment Directions in case of NBFC-BL?
C.… Regulatory requirements in case of fixed rate loans:
23.. Can prepayment charges be levied on fixed rate housing loans disbursed by an HFC?
D.… Discussion in the context of CC and OD facilities:
24.. How are cash credit/ overdraft facilities treated for levying pre-payment charges?
25.. How are conversions from OD/CC to term loans treated?
E.… Restrictions on Prepayment:
27.. How will the lock in period work in case of hybrid ROI loans?
30.. Can an RE levy prepayment charge, if the same is effected at its own instance?
31.. What is the meaning of “pre-payment is effected at the instance of the RE”?
F.… Co-lending and Digital Lending:
34.. What are the disclosure requirements under the Prepayment Directions?
35.. How should the disclosure be given in KFS?
37.. Can REs implement a slab-based charge to be levied based on prepaid percentage?
38.. How will consortium or syndicated loans be handled?
A. Applicability and Conceptual Understanding:
1. Who all are covered under the Prepayment Directions?
Response: These Directions shall apply to all commercial banks (excluding payments banks), cooperative banks, NBFCs (including HFCs) and All India Financial Institutions.
2. When do these Directions come into force?
Response: These apply to all loans and advances sanctioned or renewed on or after January 1, 2026. Any loans sanctioned before the said date shall not be covered (for compliances with respect to such loans, you may refer to our resource here).
3. If a loan is sanctioned/renewed before January 1, 2026 but disbursed thereafter, which norm shall apply?
Response: The Prepayment Directions apply based on the sanction date. A loan sanctioned before January 1, 2026 is outside the scope, even if disbursed later. Conversely, any loan sanctioned on or after January 1, 2026 falls within scope.
4. Does a top-up loan or loan enhancement sanctioned after January 1, 2026 fall within the scope of the Prepayment Directions?
Response: Yes. Any fresh sanction or renewal on or after the effective date must comply with the pre-payment charge norms.
5. Whether the provisions of Prepayment Directions are applicable to demand loans as well?
Response: Footnote 2 of the Prepayment Directions clarifies that the term ‘loans’ shall include term loans as well as demand loans. Accordingly, the restriction of charging pre-payment fees shall apply in case of both term as well as demand loans.
6. Does the provision apply only in case of part pre-payment or foreclosure as well?
Response: The distinguishing factor between pre-payment and foreclosure is that the former means early payment of scheduled installments, while the latter implies early payment of the entire outstanding amount leading to early closure of the loan term. To an extent, pre-payment is usually partial in nature whereas foreclosure is the closure of the loan account before the due-date. However, given that prepayment can be both partial or full, it could be said to be a broader term that may also cover foreclosure or full prepayment.
Further, para 5 (iii) states that prepayment penalty cannot be levied irrespective of the source of funds used for pre-payment of floating rate loans, either in part or in full. Hence, going by the intent of the regulator, the provisions should apply on both partial as well as full prepayment by the borrower and hence, covering both prepayment charges as well as foreclosure charges.
7. Whether the provisions are also applicable to dual/special rate (combination of fixed and floating rate) rate loans?
Response: In case of dual rate or special rate i.e., a combination of fixed and floating, the Prepayment Directions will be applicable if the loan is on floating rate at the time of prepayment. Prepayment at the time when the loan is on fixed rate shall be governed by the board approved policy of the lender. Note for HFCs, the extant HFC Directions also prohibit charging prepayment charges on fixed rate housing loans foreclosed with own sources (refer response to Q 19).
8. If a loan moves from fixed to floating rate mid-tenure, which rules apply at closure?
Response: Refer response to Q7 above, the status on the actual pre-payment date determines the levy of prepayment charges. If the loan is on a floating rate at the point of prepayment, the floating rate pre-payment norms shall apply, regardless of the loan being at fixed rate earlier.
8A. In case the sanctioned amount was ₹100, amount outstanding is ₹80 and the customer prepays ₹50. In this case, the prepayment charges, if leviable is to be levied on which amount?
Response: The rationale behind levy of prepayment charge is to deter the customers from prepaying the loan amount which if paid before the due date shall result in revenue loss to the lender. Therefore, the prepayment, if leviable, must be levied on the amount prepaid i.e., ₹50 is the present case.
9. What will be the applicability of the Prepayment Direction in case where at time of sanction of loan amounting to ≤ ₹50 lakh to an individual/MSE, the lender was an NBFC-BL, however, at the time of pre-payment, its classification changed to NBFC-ML?
Response: The terms of the loan are guided in accordance with the terms as was agreed at the time of sanction and communicated to the borrower.
In the case stated, consequent to change in the classification of the lender, the lender shall not be eligible to levy any prepayment charges. Hence, at the time of exercising the option of prepayment by the borrower, in case the lender is classified as an NBFC-ML, it shall not be able to impose any prepayment charges. The lender should in such circumstance waive off the levy of prepayment charges, as agreed at the time of sanction.
10. What is the difference between a fixed rate and floating rate interest loan?
Response: A fixed rate loan refers to one where interest rates remain locked throughout the loan tenure, while a floating rate term loan refers to interest rates that are subject to resets owing to certain factors. Lenders determine the floating rate on the basis of a certain reference rate. Usually, the floating rate is a spread over and above the base rate. Reference rate is determined by taking into account the cost of funds, credit cost, liquidity cost, operating expenses, expected return on equity, etc. Lenders have the option to change the reference rate prospectively depending on changes in the input factors.
11. What would be the applicability of the Pre-payment Directions in various scenarios where floating rate business loan is availed?
Response: The applicability of the Prepayment Directions should be based on the type of loan and the borrower to whom the loan has been extended. Here, given that the obligations and liability of the borrower and co-borrower is coextensive, the applicability of prepayment charges shall be determined considering both. In our view, in case either the borrower or co-borrower is an individual or MSE, the restrictions prescribed under the Prepayment Directions shall be applicable. . Hence, prepayment charges cannot be levied in the following scenarios:
| Main borrower/Applicant | Co-borrower/Co-applicant |
| Individual | MSE |
| Individual/ MSE | Non-MSE/ Non-Individual |
| Non-MSE/ Non-Individual | Individual/ MSE |
Accordingly, in case applicable lenders intend to take an exposure on non-MSE or non- Individual and levy prepayment charges, it may refrain from having any individual or MSE as the co-borrower. This levy of prepayment charges shall not be impacted in case individuals or MSE are acting as guarantors.
12. What are the parameters that lenders should check for determining the applicability for levy of prepayment charges?
Response: To understand the restrictions and applicability, the following approach may be applied by the lenders:
- Are loans extended on Floating Rate or Fixed Rate?
- In case of Floating Rate Loans, are the loans given to individuals or MSEs?
- In case of loans to individuals, is the end use for business purpose or personal purpose (including housing loans)?
- In case of loans to MSEs, is the sanctioned amount less than ₹50 lacs?
Based on the response to the aforesaid question, the various permutations and combinations that can be arrived at, has been demonstrated below:
Further, the snapshot of the applicability is as follows:
| Levy for Prepayment Charges | |||||||
| Type of Loan | Type of Interest | End Use/ Sanctioned Amount | NBFC-BL | NBFC-ML (other than HFCs) | NBFC-UL (other than HFCs) | HFCs | Banks (excluding payment banks) |
| Loans to Individuals | Fixed Rate | For Personal Use | Can be levied | Can be levied | Can be levied | Can be levied (except for housing loans foreclosed with own sources) | Can be levied |
| For Business Use | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied | ||
| Floating Rate | For Personal Use | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | |
| ≤ ₹50 lacs sanctioned for Business Use | Can be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | ||
| > ₹50 lacs sanctioned for Business Use | Can be levied | Can be levied | Cannot be levied | Can be levied (except for HFCs in Upper Layer) | Cannot be levied | ||
| Loans to Micro Small Entities | Fixed Rate | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied |
| Floating Rate | ≤ ₹50 lacs sanctioned | Can be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | |
| > ₹50 lacs sanctioned | Can be levied | Can be levied | Cannot be levied | Can be levied (except for HFCs in Upper Layer) | Cannot be levied | ||
| Loans to non-MSEs | Fixed | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied |
| Floating | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied | |
Note that in cases where pre-payment charges can be levied, the same has to be as per the internal board approved policy.
B. Regulatory requirements in case of floating rate loan:
13. What is the regulatory requirement for levy or pre-payment charges in case of floating rate interest loan?
Response: In case of floating rate loans, the Prepayment Directions provides as follows:
- No prepayment charges on loans (other than business purposes) to individuals, with or without co-obligant(s) irrespective of the amount;
- No prepayment charges on business loans to individuals/MSEs (irrespective of the repayment source, prepayment amount, or lock-in period.)by:
- Commercial banks (excluding SFB, RRB and LAB), Tier 4 Primary (Urban) Co-operative bank, NBFC-UL and AIFI.
- SFB, RRB, Tier 3 Primary (Urban) Cooperative bank, SCB, Central Cooperative bank and NBFC-ML shall not levy any pre-payment charges on loans with sanctioned amount/ limit up to ₹50 lakh.
14. Post notification of the Prepayment Directions, how has the scenario changed for NBFCs and Banks in case of floating rate business and personal loans?
Response: With respect to the levy of prepayment charges, the restrictions applicable in case of NBFCs and Banks for floating rate business loan to individual and MSE, before and after the notification of the Prepayment Directions, can be understood as follows:
| Type of RE | Before January 1, 2026 | From January 1, 2026 |
| Bank/NBFC-UL | No regulatory bar on levy or pre-payment charges. The levy shall be as per the board approved policy of the lender. | Prepayment charges cannot be levied. |
| NBFC-ML | Prepayment charges cannot be levied on loans with sanctioned amount/ limit up to ₹50 lakh | |
| NBFC-BL | No change |
In case of floating rate personal loan to individuals, prepayment charges cannot be levied by banks and NBFCs (including HFCs).
15. The limit of ₹50 lakh for not levying the pre-payment charges is on the sanctioned amount or on the amount disbursed or outstanding?
Response: Para 5(ii)(b) of the Prepayment Directions uses the phrase “sanctioned amount/ limit up to ₹50 lakh” for not levying the prepayment charges. The actual disbursement will not be relevant.
16. In case an NBFC-ML has sanctioned a floating rate term loan to an MSE of say, ₹60 lakh, however, at the time of prepayment the outstanding amount is less than ₹50 lakh (say, ₹40 lakh), in such scenario, can the lender levy prepayment charges?
Response: Refer response to Q15, in the present case, given that the sanction amount is more than ₹50 lakh, in our view, the lender being an NBFC-ML can levy the prepayment charges, as per its internal board approved policy.
17. An MSE borrower has availed ₹1 crore floating rate business loan from an NBFC-UL. This entire loan was subsequently assigned to an NBFC-ML. Post assignment, if the borrower pre-pays the loan, will the assignee be eligible to charge a pre-payment penalty?
Response: Pursuant to para 8 of the KFS Circular, “Any fees, charges, etc. which are not mentioned in the KFS, cannot be charged by the REs to the borrower at any stage during the term of the loan, without explicit consent of the borrower.” Also, in cases where the KFS is not required to be provided, as a matter of fair lending practice, any subsequent charges/penalties cannot be levied which were not leviable/levied at the time of sanction of the loan.
Accordingly, even if the assignee is an NBFC-ML and the sanctioned amount is more than ₹50 lakh, prepayment charges cannot be levied.
18. Whether the limit of ₹50 lakh also applies in case of floating rate loan disbursed by a middle layer HFC?
Response: The provisions as are applicable to NBFC-ML shall also apply to middle layer HFCs.
It may be further noted that for housing loans specifically, the limit of ₹50 lakh is not relevant since it is for other than business purposes. Further, in terms of para 85.6(a) of the HFC Master Directions, an HFC shall not charge pre-payment levy or penalty on pre-closure of housing loans where the same is on a floating interest rate basis and is pre-closed from any source.
19. What is the applicability of the Prepayment Directions in case of NBFC-BL?
Response: NBFC-BL shall not levy prepayment charges for all floating rate loans granted for purposes other than business to individuals, with or without co-obligant(s). As regards the business loans, any levy of prepayment charges shall be governed by the board approved policy of the lender.
20. In case of floating rate loans, if the resets are after a longer duration, say 1 year, will the Prepayment Directions be applicable?
Response: The provision does not provide for any timeline for reset of the rates, accordingly, as long as the loan is at a floating rate, irrespective of the timeline for reset, the provisions for floating rate loans, shall apply .
C. Regulatory requirements in case of fixed rate loans:
21. What is the regulatory requirement for levy of pre-payment charges in case of fixed rate interest loan?
Response: In case of fixed rate loans, the levy of pre-payment charges, if any, shall be based on the board- approved policy of the lender (Para 6 of Prepayment Directions). [except as discussed in Q23]
22. Post notification of the Prepayment Directions, how has the scenario changed for NBFCs and Banks in case of fixed rate business and personal loans?
Response: There has been no change in case of fixed rate loans post enactment of the present Prepayment Directions.
23. Can prepayment charges be levied on fixed rate housing loans disbursed by an HFC?
Response: In terms of para 85.6(a) of the HFC Directions, HFCs shall not charge pre-payment levy or penalty on pre-closure of housing loans in case of fixed interest rate loan if the same is preclosed by the borrower out of their “own sources”. The expression “own sources” for the purpose means any source other than by borrowing from a bank/ HFC/ NBFC and/or a financial institution.
D. Discussion in the context of CC and OD facilities:
24. How are cash credit/ overdraft facilities treated for levying pre-payment charges?
Response: In case of CC and OD, pre-payment is basically the closure of the facility before the agreed due date. As per para 6 of the Prepayment Directions, for early closure of the facility, pre-payment charges shall be levied on an amount not exceeding the sanctioned limit. However, no charges shall be levied if the borrower intimates his/ her/ its intention not to renew the facility before the period as stipulated in the loan agreement and the facility gets closed on the due date.
25. How are conversions from OD/CC to term loans treated?
Response: Converting the outstanding OD/CC balance into a term loan triggers a new sanction. Accordingly, in our view, if this conversion is before the agreed closure date of the facility, the response as is mentioned in Q24 above shall apply. However, if the conversion is at the instance of the lender, it shall not be considered for levy of prepayment charges.
E. Restrictions on Prepayment:
26. Can lenders impose restrictions on the borrower to exercise the prepayment option in the form of (i) minimum lock-in period, (ii) minimum amount/percentage of prepayment or (iii) maximum number of prepayments?
Response: Prescribing a minimum lock-in period would have the same effect as a prepayment penalty. Hence, lenders are restricted from prescribing any minimum lock in period in case of floating rate loans to individuals for personal use and to individual/ MSEs for business purposes as per Para 5(i) and 5(ii).
| Restriction | Floating Rate loans covered under para 5 (i) and (ii) | Other loans |
| Minimum lock-in period | Cannot be specified by the lender. | Reasonable lock-in say in case of long tenure loans can be specified. |
| Minimum amount/ percentage of prepayment | The provisions are silent on the same, however, in our view, given the operational issues, a reasonable amount/ number of EMIs can be specified to be considered for prepayment.. | A reasonable amount/ number of EMIs can be specified considering operational challenges. |
| Maximum instances of prepayment option | The provisions are silent on the same, however, in our view, given the operational issues, a reasonable number can be specified for the borrower to exercise the prepayment option. | Can be specified based on operational issues. |
It may be noted that refusing to accept early repayment of debt would be considered an “unfair contract” under Consumer Protection Act, 2019 (Section 2(46)). Hence, in cases where the lender may impose a prepayment penalty but it has prescribed restrictions such as lock-in period or minimum percentage of prepayment, the same may be seen as an unfair practice.
27. How will the lock in period work in case of hybrid ROI loans?
Response: The bar on levy of prepayment charges under the Prepayment Directions is on floating rate business loans to individuals and MSE. Now, if the interest rate on the loan is structured in such a manner that for the initial period of say, 2 years, it is on fixed rate basis, and thereafter floating, in our view, lock-in terms may be applicable for the said period when the loan is on fixed rate.
28. With the removal of lock-in, does it make sense for lenders to offer hybrid interest rate loans?
Response: Given commercial considerations (such as various costs incurred by the lender, like the admin costs), a hybrid interest rate model with part-fixed and part-floating rate of interest may be explored by lenders (which is practiced by many housing finance institutions).
During the fixed-rate period, the lender may have a lock-in period / levy prepayment penalty as per its Board Approved Policy as per Para 6 (except in case of HFCs where borrower has prepaid with own funds). During the floating rate phase, there cannot be any lock-in period, however, a reasonable minimum amount/ minimum number of EMIs/ maximum instances can be specified to be considered for prepayment
29. In light of the Prepayment Directions, what additional items should be covered in the prepayment charges policy?
Response: As regards the contents of the policy, in our view, considering the intent and requirement in the present case, the policy among other things must also ensure the following:
- For term loans, pre-payment charges shall be based on the amount being prepaid.
- For cash credit/ overdraft facilities, pre-payment charges on closure of the facility before the due date shall be levied on an amount not exceeding the sanctioned limit.
- Further, no pre-payment charges shall be applicable if the borrower intimates the lender of its intention not to renew the facility before the period as stipulated in the loan agreement and the facility gets closed on the due date.
30. Can an RE levy prepayment charge, if the same is effected at its own instance?
Response: Para 8 of the Prepayment Directions clarifies that an RE shall not levy any charges where pre-payment is effected at the instance of the RE.
31. What is the meaning of “pre-payment is effected at the instance of the RE”?
Response: The literal meaning of the phrase is, whenever the lender is asking the borrower to prepay the loan before the due date. This would refer to such cases where the lender has a right to force prepayment/ accelerate repayments upon occurrence of such events as specified in the loan agreement. For instance, occurrence of any event of default or any adverse material change, consequent to which the lender may ask the borrower to either prepay the loan or accept higher interest. Further, in case of CC/OD, the lender may offer the borrower to convert the facility to a term loan before the end of term of the facility.
F. Co-lending and Digital Lending:
32. In a co-lending arrangement between (i) NBFC-UL and ML, (ii) NBFC-UL and BL, (iii) NBFC-ML and BL, what will be the applicability of the Prepayment Directions for floating rate business loan to individual/MSE?
Response: Given the dissimilar applicability of the provisions of the Prepayment Directions in case of NBFC-UL (cannot levy at all), ML (cannot levy where sanctioned amount is ≤ 50 lakh) and BL (to be guided by the board approved policy), the ambiguity w.r.t. the applicability of the Prepayment Directions will arise in case of co-lending by these entries.
Ideally, the prepayment penalty should be levied by the lenders on their respective loan share. Hence, the borrower should be informed and communicated about the levy of prepayment charge on one part of the loan (co-lent by NBFC-BL) and no charges on the other part (co-lent by NBFC-UL). At the time of prepayment, the amount shall be distributed between the co-lenders based on the respective loan share and the prepayment charges shall only be levied on one part.
Alternatively, the lenders may mutually agree to apply the restriction if applicable on any one of the co-lender, for the entire loans originated under a co-lending arrangement.
33. A borrower uses a digital lending app to pre-pay via UPI. The UPI app charges a convenience fee. Can this be levied if the underlying loan does not carry pre-payment charges?
Response: Charges levied by UPI apps for making the payments are not linked with the prepayment charges. Accordingly, as per the usage terms of the application, the same may be levied.
G. Disclosure requirements:
34. What are the disclosure requirements under the Prepayment Directions?
Response: The applicability or otherwise of pre-payment charges shall be clearly disclosed in (i) sanction letter and (ii) loan agreement. Further, in case of loans and advances where Key Facts Statement (KFS) is to be provided as specified in the Circular dated April 15, 2024 on ‘Key Facts Statement for Loans and Advances’ i.e., in cases of all retail and MSME term loan products, the applicability or otherwise of the prepayment charges shall also be mentioned in the KFS.
35. How should the disclosure be given in KFS?
Response: For loans requiring a KFS, the pre-payment charges section must list the exact charges or state “nil” if no charges apply.
H. Other concerns:
36. Can an RE waive off the charges at the time of pre-payment of loans and subsequently reimpose the same ?
Response: The RE has the discretion to waive off the prepayment charges based on the merits of the specific case of the borrower. However, RE shall not levy any charges/ fees retrospectively at the time of pre-payment of loans, which were waived off earlier by the RE. [Refer Para 10 of the Prepayment Direction]
37. Can REs implement a slab-based charge to be levied based on prepaid percentage?
Response: Yes, where charges are permissible, REs may structure a schedule of fees corresponding to the prepaid amount/percentage. This slab must be transparent, disclosed upfront and applied uniformly.
38. How will consortium or syndicated loans be handled?
Response: In our view, pre-payments charges, if applicable, shall be as per the loan agreement executed between the lenders and borrower.
[1] Read our article “Do you pay to prepay?” analysing the Directions at: https://vinodkothari.com/2025/07/levy-of-prepayment-charges/
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