Foreclosure Charge on a Floating-Rate Home Loan
A borrower took a Rs 35,00,000 floating-rate home loan four years ago. The outstanding principal is Rs 28,40,000. He wants to prepay the entire amount from the sale of another property. The branch officer tells him a 2% foreclosure charge (Rs 56,800) and a Rs 5,000 'switching fee' will apply, citing a clause in the loan agreement. The borrower says he was never told about a prepayment penalty and that the loan is floating-rate. The branch manager must respond in writing the same day. The loan is to an individual for a residential property, and the borrower is not refinancing from another lender; he is using his own sale proceeds. The manager also has a fixed-rate home-loan customer who is asking the same question about prepayment.
1. Is the 2% foreclosure charge permissible? Explain the rule and how it applies to these facts.
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No. For an individual borrower with a floating-rate home loan, foreclosure charges or prepayment penalties are not permitted. The loan agreement's clause cannot override that position. The charge is therefore not collectable on these facts, and the branch should waive the Rs 56,800.
The Rs 5,000 'switching fee' is a separate question. A switching fee is normally an administrative charge for moving a loan to another lender. This borrower is not switching lenders; he is prepaying from the sale of his own property. Labelling a prepayment charge as a switching fee does not make it permissible. The manager should verify the agreement and the fee schedule, but if the amount is in substance a foreclosure charge, it should also be waived. The written reply should distinguish the two charges, state the waiver clearly, and avoid conceding that the branch deliberately misled the borrower.
2. Draft the core message to the borrower, including what to verify before confirming waiver.
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The reply should be short, written and unambiguous:
- Confirm that the loan is a floating-rate home loan to an individual for a residential property.
- State that, on review, no foreclosure charge is payable on prepayment of that loan, and that the proposed 2% charge of Rs 56,800 will not be collected.
- State that the Rs 5,000 switching fee does not apply because the borrower is not switching to another lender; confirm whether any separate administrative charge is actually disclosed for the prepayment service.
- Ask for a written prepayment request and the proposed date, and provide a fresh no-dues statement showing principal, accrued interest and any genuine charges.
Before sending, the manager should verify the loan agreement, the sanction letter, the current rate type, and whether any part of the loan is fixed-rate. The manager should also check that the waiver is recorded in the system so the borrower is not asked to pay at the counter.
3. How should the manager handle the fixed-rate customer's request?
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The fixed-rate customer must not be given the floating-rate answer automatically. For a fixed-rate loan, a prepayment penalty may be charged if the loan agreement discloses it, the amount is reasonable, and the charge is applied consistently. The manager should first check the agreement and the fee schedule, then give the customer the exact calculation in writing before accepting prepayment.
If the agreement is silent on prepayment charges, the branch should not invent one. If a charge is disclosed, the manager should explain the basis, allow the customer to compare prepaying now against continuing the loan, and record the customer's consent. The branch should also check whether the loan is a hybrid or has a fixed-rate period, because the answer may change at the reset date. The key discipline is to classify the rate type first, then apply the correct rule, rather than treating all home loans alike.