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 allows borrowers extra time before they need to start repaying their loans.

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 rather a deferment of the payment schedule, providing borrowers breathing space during financial hardship. The concept of a moratorium is especially relevant in situations like natural disasters, widespread economic crises, or personal financial upheavals.

How Does a Loan Moratorium Work?

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

1. Application and Approval: Borrowers typically need to apply for a loan moratorium through their lending institution. The lender will assess the situation and determine eligibility based on predefined criteria. Approval is not automatic and requires documentation of financial hardship.

2. Moratorium Period: Once approved, the moratorium period begins. During this time, no monthly payments are required. This period generally lasts from one to twelve months, depending on the lender’s policies and the severity of the situation.

3. Interest Accrual: While no payments are made during the moratorium, interest may still accrue on the principal. This means that while the immediate financial burden is eased, the total loan amount may increase.

4. Resumption of Payments: After the loan moratorium period ends, borrowers must resume their payment schedule. In some cases, the loan terms might be adjusted to accommodate the higher balance resulting from accrued interest.

Read more: How to take personal loans for students in India?

Loan EMI Moratorium

An EMI (Equated Monthly Instalment) loan moratorium refers to the suspension of monthly instalment payments. This is commonly associated with home, personal, and education loans, where EMIs represent a significant financial commitment. During an EMI moratorium, the borrower doesn’t make monthly payments, but interest may still accrue, potentially extending the loan tenure or increasing 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.

Read more: What are personal loan foreclosure charges?

Loan Moratorium Extension

In prolonged periods of financial instability, borrowers may find that the initial loan moratorium period is insufficient. In such cases, an extension may be sought. Here’s how a loan moratorium extension works:

• 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 financial hardship.

• Adjustments to Loan Terms: Extensions may lead to further adjustments in loan terms, such as increased tenure or changes in interest rates to accommodate the extended moratorium period.

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.

Read more: Factors that affect your credit score

FAQs

1. Does interest accrue during a loan moratorium?

Yes, in most cases, interest continues to accrue during the moratorium period. This means that while borrowers are not making payments, the total amount owed may increase unless the lender specifies otherwise. 

2. Will taking a loan moratorium affect my credit score?

Opting for a loan moratorium does not affect your credit score, as it is an officially approved deferment by the lender. However, it’s essential to confirm this with your financial institution to ensure there are no unexpected impacts on your credit history.

3. What is an EMI loan moratorium?

An EMI (Equated Monthly Instalment) loan moratorium refers to the suspension of monthly EMI payments. It is commonly applied to home loans, personal loans, and education loans. During the moratorium period, borrowers do not make EMI payments, but interest might continue to accrue, affecting the overall loan tenure or the amount of subsequent EMIs.

4. Can I extend the loan moratorium period?

Yes, borrowers can apply for a loan moratorium extension if they continue to face financial hardship. The lender will assess the situation and may approve an extension, often with adjustments to the loan terms, such as an increased tenure or changes in interest rates.