What is Loan Moratorium and how does it affect a borrower?

The loan moratorium has been widely discussed in India since the onset of the Covid-19 pandemic. The country’s central bank initially offered a moratorium on all term loans for a period of three months, which was later extended by three more months from March 2020 to August 2020, to help borrowers take loans amid the pandemic-induced economic slowdown. to provide temporary relief.

What is Loan Moratorium
What is Loan Moratorium

Here’s what you need to know about loan moratoriums and how they charge borrowers.

What is Loan Moratorium?

A loan moratorium is a legally authorized period in which payment of funds is delayed due to specific loan installments. The way it works is simple:

The standard loan practice is to repay your loan as soon as it is disbursed.

A moratorium period delays this repayment and allows a grace period before the borrower can start repaying the loan through Fixed Monthly Payments (EMIs).

With borrowers not having to start repaying their loan immediately after disbursement, they can avail what is known as an EMI holiday and start paying EMIs after a break.

Who is eligible for a loan moratorium?

While loan moratoriums are available on all types of loans including home loans, personal loans, education loans and credit card dues, students are most likely to use the moratorium. Since there can be a gap of several months or years between students completing their educational program and getting a job, most student loans have a default provision for a repayment holiday or moratorium.

Apart from student loans, home loans are most likely to have moratorium provisions as they are big ticket amounts and the borrower may need time to get through his financial matters before initiating the repayment process.

How is the interest calculated on the loan during the moratorium period?

During the moratorium period, your lender will calculate the interest on your loan by applying the concept of simple interest. Interest will be calculated only on the amount actually paid and not on the entire loan amount.

The interest charged on the loan during the moratorium period will be applicable and will then be added to the principal amount of the loan. Hence, after your EMI holiday is over, you need to start paying your EMIs, which will consist of the interest and principal amount accumulated during the moratorium period.

Can I pay my interest amount during the moratorium period?

If you are financially ready to pay your loan EMIs during your moratorium period itself, you may be able to enjoy concessional interest rates. So, if you manage to fix your financial woes, it would be good to repay your loan during the moratorium period. 

This is true, especially because during your moratorium period, the interest will be lower. As the months go by, your interest will increase and you will be forced to pay a much higher amount after your ‘repayment holiday’.

Loans that come with Moratorium Period

In India, very few loans are given by the lender with the moratorium period. The two main loan options that offer the moratorium period include education loan and home loan. To understand why only these loans are provided with the benefit of moratorium period, let us try to understand how both these loans work.

1. Education Loan

Education loan refers to a loan that is taken by an individual to meet his education expenses. It is mostly taken for funding higher education courses like undergraduate, postgraduate, doctoral studies, research studies etc.

Since a student or a student’s parent or guardian applies for this loan, the student will not have income at that time to repay the loan. So, once the student completes the course and then starts earning money from his job, the loan can be repaid.

This difference in the loan tenure during which the borrower does not have to pay anything is known as the moratorium period. This is a very important element of an education loan. Education loan can be taken for education within the country or outside the country.

2. Home Loan

Home loan refers to a loan that is provided for the purpose of buying a house or flat. They follow fixed or adjustable payment conditions and interest rates. 

In a home loan, the lender gives a fixed moratorium period so that the borrower can take his time to manage all his other expenses and then gradually start paying the EMIs for the loan. This EMI is given to help the holiday borrower to settle his finances.

Difference Between Moratorium Period and Grace Period Many people think that moratorium period and grace period are same. They often confuse a moratorium period for a grace period. However, the truth is that the two are not the same. A moratorium period refers to the period during which your lender does not ask you to make any repayment. 

This period is given because the borrower may be short of funds or may have some financial difficulty. Your lender will understand your current financial situation and give you a few months to resolve your financial struggles and get back on track. Once this is done, you can start repaying your loan by paying EMIs immediately.

A bank or an NBFC gives a loan moratorium period to prevent the borrower from defaulting on any EMI or absconding without repaying the loan. On the other hand, a grace period is described as a period in which some additional time is given to repay the loan outstanding. This period is given to the borrower when the loan repayment deadline has arrived and the payment is required to be made.

Your lender may give you a grace period during which no interest will be charged from you by your lender. The borrower will need to ensure that the loan is fully cleared within the grace period. Once the grace period is over, if the borrower has still not paid the dues, he will be asked to pay the late payment fee or penalty. During the grace period, interest will not be charged.

A moratorium period and a grace period are somewhat similar because during both these periods, a borrower does not have to pay anything. However, a moratorium period is longer than a grace period. A borrower will need to request a moratorium period from the lender stating their financial difficulty, and the lender will need to accept the same. 

There is no guarantee that one will be given the moratorium period. Conversely, when a lender offers a grace period for a certain loan product, all borrowers can enjoy this grace period. In a moratorium period, interest is most likely paid, as opposed to a grace period, where interest is never charged.

A moratorium period is a very good feature which is given by the lenders to the borrower as it helps them to resolve their financial difficulties and then start repaying the loan with a fresh start.

Before applying for the loan, you can check with your banker about all the terms and conditions regarding the moratorium period and then take a decision accordingly.

What are the benefits of loan moratorium?

1. Better Repayment Plan:

A loan moratorium can help a borrower plan his repayment strategy in a stress-free manner. It can help them to pool money from various sources and start repayments in a systematic manner instead of rushing to make payments without proper finances. 

The loan moratorium period can be used to plan monthly income and expenses and can help the borrower save on future EMIs and miscellaneous expenses.

2. No Negative Impact on Credit Score:

One of the most important benefits of loan moratorium is that it does not negatively affect your credit score. Simply put, non-payment of the loan through regular installments does not adversely affect the credit score of the borrower. Hence, the moratorium period does not have any impact on your borrowing ability.

3. Helps During Liquidity Crisis:

The COVID-19 pandemic is a reminder of how devastating the impact of an event can be on the global economy. Millions of people have lost their savings due to job loss or the death of the main earning member of the family. Therefore, cash crunch or cash crunch is a real situation for many people.

A loan moratorium can be helpful in such a situation as it can help you tide over a tough financial crisis. This is especially helpful for those who are facing low wages or those who work in the unorganized sector or small businesses that have faced a sharp drop in their profits during the pandemic. 

A temporary pause in repayment of a loan can help individuals in any crisis to take stock of their financial situation and plan for a better future.

What are the drawbacks of loan moratorium?

1. No Interest Waiver:

One of the biggest drawbacks of a loan moratorium is that the loan repayment is not waived, but only deferred. This means that as a borrower you still pay interest to your bank or your lender. The moratorium may also result in additional interest charges which may further put pressure on your future payments.

2. Sudden Burden:

While a temporary pause from loan repayments provides short-term relief, the fact of the matter is that the backlog of interest eventually catches up with you. And if you haven’t planned ahead, the sudden burden of huge payments can derail your monthly budget and disrupt your cash flow.

3. Increase in Loan Tenure:

The longer tenure of EMI break automatically leads to longer term loan. For example, if you avail the moratorium on a loan to be repaid in three years, the repayment period will now be extended to four or five years. This can negatively impact your long-term financial goals and derail your plans for debt-free financial stability.