The Reserve Bank of India (RBI) has mandated banks to offer fixed interest rates on all personal loans with EMIs.

Banks should provide borrowers the option to switch over to a fixed rate as per their board approved policy at the time of reset of interest rates, as per the RBI's FAQs on 'Reset of Floating Interest Rate on Equated Monthly Instalments based Personal Loans'.

The RBI said borrowers should have different options available to them with regard to EMI-based personal loans, including switching to fixed interest rate for the remaining portion of the loan.

The other options include enhancement in EMI or elongation of the number of EMIs, keeping the EMI unchanged, or a combination of both options; and prepayment, either in part or in full, at any point during the residual tenor of the loan.

The intent of the circular, RBI said, is to allow flexibility to the customer to switch from floating rate loan to fixed rate loan or vice versa.

The lender can levy charges for switching of loans or any other service charges/administrative costs incidental to the exercise of the switchover options. This shall be transparently disclosed in the sanction letter and at the time of revision of such charges/costs by the lender, RBI said.

The FAQs on 'Reset of Floating Interest Rate on EMI based Personal Loans' (August 2023) said the circular covers all equated installment based personal loans, irrespective of whether the interest rate is linked to an external benchmark or an internal benchmark.

At the time of sanction of loans, annualised rate of interest/ annual percentage rate (APR), as applicable, should be disclosed in the Key Fact Statement (KFS) and the loan agreement. Also mentioned should be when and at what frequency banks and other regulated entities (REs) communicate with the borrower, the FAQs said.

During the tenure of the loan, any increase in the EMI/tenor on account of the external benchmark rate should be communicated.

The quarterly statements should be provided disclosing at the minimum, the principal and interest recovered till date, EMI amount, number of EMIs left and annualised rate of interest for the tenor of the loan.

In August 2023, the RBI directed banks to allow individual borrowers paying loans through EMIs to opt for a fixed interest rate system or extension of loan tenor, a move aimed at preventing loanees from falling into the trap of negative amortisation, in wake of rising interest rate.

The interest rates have moved northward since May 2022 after the central bank started raising the benchmark lending rate (repo) in a bid to check inflation following the outbreak of the Russia-Ukraine war.

As a result of a 250 basis points increase in the repo rate, a large number of borrowers faced negative amortisation, wherein the EMI works out to be less than the interest obligation, resulting in a persistent increase of the principal amount.