Loan Moratorium: What it is and how it works

In times of financial crises or economic downturns, individuals and businesses often find themselves struggling to keep up with their personal loan or any other loan repayments. Recognising these challenges, financial institutions may offer a solution known as a loan moratorium, which is a way to allow the borrower some extra time before they can start making their loan repayments.

In this blog, we will break down what the term loan moratorium is, how the process of a loan moratorium works and what are the specific conditions when one can get this facility.

What is a Loan Moratorium?

A loan moratorium refers to a legally sanctioned period during which borrowers are allowed to pause their loan repayments. This temporary relief is not a cancellation of the debt but merely a deferment of the payment schedule, giving borrowers breathing space during financial hardship. The concept of a moratorium is especially relevant in scenarios like natural disasters, widespread economic crises, or personal financial upheaval.

How Does a Loan Moratorium Work?

When a moratorium is declared, the regular payments of principal and interest on a loan are put on hold for a specified period. It’s important to understand that interest may continue to accrue during this period, depending on the lender’s policies and the terms of the moratorium. Here’s a closer look at how a loan moratorium works:

1. Application and Approval: Typically, borrowers must apply for a moratorium through their lending institution, which will assess the situation and determine eligibility based on predefined criteria. Approval is not automatic and requires documentation of the financial hardship being experienced.
2. Moratorium Period: Once approved, the moratorium period begins. During this time, no monthly payments are required. The length of this period can vary but generally lasts from one to twelve months, depending on the severity of the situation and the lender’s policies.
3. Interest Accrual: During the moratorium, interest may still accrue on the principal amount. This means that while the immediate financial burden is reduced, the overall amount owed might increase unless the moratorium specifies otherwise.
4. Resumption of Payments: After the moratorium period ends, borrowers are expected to resume their regular payment schedule. In some cases, the terms of the loan might be restructured to adjust for the higher outstanding balance due to accrued interest.

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Loan EMI Moratorium

An EMI (Equated Monthly Instalment) moratorium specifically refers to the suspension of monthly instalment payments on a loan. This type of moratorium is commonly associated with home loans, personal loans, and education loans, where EMIs represent a significant financial commitment. During an EMI moratorium, the borrower does not make monthly payments, but interest may continue to accrue, which can extend the loan’s tenure or increase the amount of subsequent EMIs.

The Impact of a Loan Moratorium

The primary benefit of a loan moratorium is the temporary financial relief it offers, allowing borrowers to stabilize their finances without the pressure of immediate repayments. However, there are several impacts and considerations:

• Credit Score: Typically, taking advantage of a moratorium offered by the lender does not affect the borrower’s credit score, as it is an officially sanctioned deferment. However, it’s crucial to confirm this with the lending institution to avoid surprises.
• Increased Cost: Since interest might continue to accrue during the moratorium period, the total cost of the loan can increase. Borrowers should calculate these costs to make informed financial decisions.
• Cash Flow Management: For businesses, a loan moratorium can help manage cash flow more effectively during downturns, allowing them to allocate resources to critical areas of operation.

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Loan Moratorium Extension

In prolonged periods of financial instability or when the economic environment worsens, borrowers might find that the initial moratorium period is not sufficient. In such cases, a loan moratorium extension can be sought. Here’s what this entails:

• Application for Extension: Borrowers must apply for an extension, providing evidence that their financial difficulties persist.
• Lender’s Assessment: The lender will reassess the borrower’s situation and may grant an extension based on the continued impact of the hardship on the borrower’s financial status.
• Adjustments to Loan Terms: Extensions might lead to further adjustments in the loan terms, such as an increased tenure or changes in the interest rates, to accommodate the extended period without payments.

A loan moratorium can be a lifeline for borrowers facing temporary financial difficulties, allowing them to defer loan payments without damaging their credit score. However, it’s important for borrowers to understand the full implications of entering into a moratorium, including the potential for increased total loan costs due to accruing interest.

If you are considering this option for your business, make sure to inform your bank or lender and get a detailed idea of the bank’s loan moratorium offers.

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