Summary of this article
Failed auto-debits add multiple charges that increase total dues.
Missed payments can lower credit scores and limit borrowing options.
Rules require advance alerts before recurring payments are deducted.
Automated electronic payments, also known as auto-debits, have become the default mechanism of paying regular payments such as loan equated monthly instalments (EMIs) and insurance premiums. However, if adequate balance is not maintained in the linked bank account, one failure of this system leads to immediate and escalating financial penalties.
On the failure of an auto-debit instruction, the lender charges a bounce fee on its return. This amount may vary from bank to bank and mostly lies in the range of Rs 200 to Rs 500 for each such failed transaction. Sometimes, this might be even higher depending on the lender. This amount gets added instantly to the outstanding amount, starting a cycle of subsequent penalties.
The Double Penalty: Late Fees and Penal Charges
Two critical charges that are levied in addition to the above, in case of a failed payment, are late fees and penalty charges. The late payment fee is either a fixed fee or a fee structured on the basis of the overdue amount.
For loan EMIs, this is typically a one-time charge. For credit cards, the fee is tiered, most of the time ranging from Rs 250 to over Rs 1,500, depending on the total balance on the card statement. Some banks also levy a monthly penalty at around 2-3 per cent on the overdue amount, besides extra bank charges for bounced auto-debits.
The other one is the penal charge. Regulators now require penalties for loan defaults to be levied as "penal charges" and not as "penal interest." These charges are applied to the defaulted amount. Lenders are now explicitly mandated not to capitalise on penal charges, meaning interest cannot be calculated on the penalty itself. The regular interest, however, continues to accrue on the original unpaid principal and interest.
An average penal rate of 24-36 per cent per year (2-3 per cent a month) is charged on the defaulted amount for missed loans EMIs until the payment is regularised. The combination of the bounce fee, the late fee, and penal charges takes the final amount required to clear the missed EMI substantially higher than the instalment amount.
The Snowball Effect on Credit Rating
The most damaging consequence of a failed auto-debit is the negative mark on the borrowers' credit score, for which repayment history is the main component of the score calculation. Penalties start accruing from the very next day following the due date. In case of credit cards, at least a three-day grace period is required to be given to the borrower before a late fee can be levied.
While payments late by less than 30 days are usually not reported to credit bureaus, they are noted internally by the lender. If the payment lapses beyond 30 days, it is then reported by the lender to the credit bureaus with "30+ Days Past Due" status, which may immediately lower the borrower's credit score.
If the payment is delayed more than 90 days (three months), the account is labelled a Non-Performing Asset or NPA. The credit rating takes a severe drop, following which the borrower faces restrictions in availing any fresh loans, credit cards, or refinancing for a couple of years. A low credit score compels the borrower to settle for higher interest rates for any loan in the future, even if the application gets approved.
Minimising the Risk
Borrowers should always maintain a sufficient extra amount in the account linked with the auto-debit so that the automatic transaction can be smoothly completed without any hurdle.
In the interest of consumer control, the Reserve Bank of India (RBI) has made it compulsory that for recurring payments above Rs 15,000, an additional factor authentication, such as an OTP entered by the customer, is required for the transaction to be completed.
According to RBI's 'e-mandate framework' for recurring card or mandate-based payments, issuers are mandated to send a pre-debit notification to the customer at least 24 hours before the debit. The notification should contain details like the name of the merchant, amount, date and time of debit, and reference number. The customer is also mandated to have an option to opt out of the transaction or the mandate.
