What is penal interest?

"Penal interest" is a commonly used older expression, but RBI now requires a penalty for non-compliance with loan terms to be treated as a penal charge rather than an additional penal rate of interest.

The charge must be:

• Reasonable
• Disclosed
• Linked to the specific default

It should not be capitalised so that further interest is calculated on the penal charge itself.

Normal contracted interest can still continue on the outstanding loan.

Normal interest and penalty have different purposes

Normal interest is the agreed price for borrowing.

A penal charge is imposed because a material term of the loan was not followed.

For example:

• A payment remained overdue
• The account exceeded permitted limits

These are separate from the normal interest charged for using the borrowed money.

What RBI changed

The RBI directions on penal charges say that penalties should not be added as "penal interest" to the normal loan rate.

They should also not be capitalised.

Lenders must have a board-approved policy and clearly disclose the:

• Amount of the charge
• Reason for the charge

What can still accrue

The rule does not stop normal interest from continuing on the outstanding loan balance.

It also does not prevent the lender's usual compounding method for normal loan interest.

What it prevents is the penalty itself becoming a hidden additional interest rate on which further interest is charged.

How to check a statement

Look for separate entries for:

• Normal interest
• Overdue amount
• Bounce fee
• Penal charge

If a penalty is unclear, compare it with the Key Fact Statement and lender fee schedule.

You can also ask the lender for a calculation showing why the charge was applied.

Act before the account escalates

If a payment is missed:

1. Obtain the exact amount required to regularise the account.
2. Confirm the approved payment channel.
3. Pay the undisputed amount promptly.
4. Save the payment receipt.
5. Confirm that overdue flags or withdrawal restrictions have been removed.

If the penal charge itself is unclear, raise a written query without postponing payment of the undisputed amount.

Information on this page is general in nature. Eligibility, approved schemes, LTV, rates and charges depend on the regulated lender's current policy and the final loan documents. This is not financial advice. The content is purely for educational purposes.