MSME owners won’t be charged 2% or any other prepayment charge on their loans, applicable from 1st January, 2026.

On July 2, 2025, the RBI issued a press release with this being the first line: “Availability of easy and affordable financing to micro and small enterprises (MSMEs) is of paramount importance.”

This press release is important for commercial banks (excluding payment banks), cooperative banks, NBFCs, and all other Indian financial institutions. This is a must-read document for all the sanctioning authorities and loan borrowers regarding the renewal or repayment of loans.

Will this removal of prepayment charges benefit the MSMEs?

Which Loan Borrowers Don’t Have To Pay Prepayment Charges In 2025?

The Reserve Bank of India (RBI) has directed the REs (Regulatory Entities) to:

Status of Prepayment	Business Loans (Taken by Individuals and MSMEs)	Non-Business Loans
Charged/Not Charged	Not Charged	Not Charged

However, as per the RBI circular on 2nd July, 2025, there will be no prepayment charges levied by REs like Small Finance Banks, Regional Rural Banks, Tier 3 Urban Co-op Banks, Central Co-op Banks, and NBFC-Middle Layer (NBFC-ML) if the loan’s value is less than ₹50 lakh.

Effect of Source of Funds on Prepayment Charges for MSME Loans

MSME business owners often get confused on how to justify the source of the funds to make the prepayment of the loans. Secondly, in some cases, banks refuse to waive off the prepayments based on the source of the funds.

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As per the new RBI update, the provision of removal of prepayment charges is applicable irrespective of the source of the funds (e.g., own funds or balance transfer.) Secondly, the provision is applicable even if the prepayment is partial or in full and there’s no lock-in period for the same.

Disclaimer: These conditions apply only if the loan is based on a floating interest rate. For dual/special rate loans, the REs must check the loan sanction documents before waiving off the prepayment charges.

Pre-payment Charges in Other Cases

For loans that do not fall under the specific categories where pre-payment charges are explicitly waived, regulated entities (REs) can still levy charges.

However, this must strictly follow their approved internal policies.

Summary Table:

Loan Type	Basis for Pre-payment Charges
Term Loans	Charges to be based on the amount being prepaid
Cash Credit/OD	Charges can be levied only on the sanctioned limit, not on the utilised amount

This condition ensures that borrowers are not unfairly penalised beyond the agreed terms.

Closure of Credit Facilities

Borrowers who decide not to renew cash credit or overdraft facilities can avoid any pre-payment penalties if:

They inform the RE in advance (as per the terms in the loan agreement), and
The facility is closed on the stipulated due date.

This move empowers borrowers with flexibility and promotes transparency in financial contracts.

RBI-Initiated Prepayment

In instances where the pre-payment is initiated by the regulated entity itself—for example, in case of recall of loans—no charges shall be levied on the borrower.

This provision ensures that borrowers are not unfairly burdened for decisions taken solely by the lender.

Mandatory Disclosures

To eliminate hidden charges and promote full transparency, RBI mandates that the applicability or non-applicability of pre-payment charges must be disclosed in the following:

Document	Disclosure Requirement
Sanction Letter	Must clearly mention pre-payment terms
Loan Agreement	Must explicitly state any applicable charges
Key Facts Statement (KFS)	Pre-payment terms must be mentioned (if applicable)

Note: No pre-payment charges can be imposed unless disclosed in these documents.

Retrospective Charges Prohibited

The RBI has clearly stated that charges or fees previously waived by the lender cannot be reimposed at the time of prepayment. This protects borrowers from arbitrary and retrospective cost impositions, ensuring that loan contracts remain predictable.

Repealed Guidelines

With the introduction of these new directions, the RBI has repealed several earlier circulars and instructions issued between 2012 and 2023. These include:

Circulars related to foreclosure/pre-payment penalties on floating rate home loans
Relevant paragraphs in the Master Directions for NBFCs and Housing Finance Companies

This move consolidates and updates RBI’s stance on pre-payment across the financial system.

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Examples of Repealed Circulars

Circular Date	Subject
June 5, 2012	Foreclosure Charges on Home Loans
May 7, 2014	Pre-payment Penalty on Floating Rate Term Loans
August 2, 2019	Floating Rate Term Loans – Penalty Guidelines
Oct 19, 2023	Scale-Based Regulations for NBFCs – Paragraph 45.7.4

Conclusion

The RBI’s updated directions mark a significant step toward borrower-friendly lending practices. By banning hidden charges, regulating prepayment penalties, and enforcing transparent disclosure, the guidelines are set to:

Empower borrowers with more control over their loans
Facilitate competition by allowing easy loan switching
Ensure fair play across all financial institutions

These reforms are especially beneficial for individual borrowers and Micro & Small Enterprises (MSEs), offering them greater financial flexibility without penalty.

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