A fixed rate of interest or floating rate of interest are terms that will be introduced to you when you are in the market for a new loan. Whether it is a home loan or a personal loan, understanding these terms can help you make an informed choice as to which is the right type of interest rate for you, keeping in mind your financial requirements and repayment capacity. Here is everything you need to know about these two terms.
What is Fixed Interest Rate?
A fixed rate of interest means that your interest rate remains the same throughout your loan repayment tenure. It does not vary even if there is any change in the lending rates of banks or repo rates of the Reserve Bank of India (RBI). Equated Monthly Instalments (EMI) will remain the same throughout the tenure. Some lenders offer loans that have a fixed rate of interest only for the first few years of the tenure, switching to a floating interest rate later.
Benefits of Fixed Interest Rate
These are the benefits of a fixed interest rate based on various parameters:
- Interest rate: The interest rate remains constant throughout the entire loan tenure and is not affected by market conditions.
- EMI: Since this interest rate doesn’t fluctuate over time, your EMI remains fixed, making it easier to more accurately plan your monthly budget and long-term financial savings or investments.
Drawbacks of Fixed Interest Rate
Some of the drawbacks of a fixed interest rate are as follows:
- The fixed interest rate is usually 1% to 2.5% higher than the floating interest rate offered by a bank or non-banking financing company (NBFC).
- Even if the fixed interest rate reduces after an announcement from the Government or Reserve Bank of India (RBI), it doesn’t affect the loans already borrowed using the previous interest rate. The borrower will have to continue repayment at the higher interest rate even after a rate cut.
- Many a times, the fixed rate of interest is only valid for a couple of years after which the interest rate gets revised according to the ongoing rate.
Why choose a Fixed Interest Rate?
These are some of the scenarios in which a fixed rate of interest may be beneficial for you:
- You prefer a fixed repayment schedule and are comfortable paying the current interest amount. You should ensure that your monthly installment isn’t more than 30% of your net monthly salary.
- You foresee a rise in the interest rate in the future and, therefore, want to ensure that your interest amount doesn’t increase more than what you are currently paying. In such a scenario, the fixed interest rate can be used to lock in the current rate of interest being offered by the lender.
- In cases where there has been a decline in the interest rates and it is likely to remain the same for a few more years.
What is Floating Interest Rate?
A floating interest rate varies with the market scenario. The interest will be calculated on a base rate with a floating element being added so that when the base rate changes, the floating rate also changes.
Benefits of Floating Interest Rate
The benefits of a floating interest rate are as follows:
- Floating interest rates are usually set 1% to 2.5% lower than the fixed interest rate offered by the same lender.
- The floating interest rates offered by a bank or non-banking financing company is usually lower than the fixed rates it offers its customers. Therefore, it means that even if the floating interest rate increases, it can still be less than the previous fixed interest rate offered.
- In case the floating interest rate exceeds the interest rate, it will not be for the entire loan tenure. There are chances that the floating rates might come down after a certain period of time.
Drawbacks of Floating Interest Rate
The drawbacks of a floating interest rate are as follows:
- Due to the fluctuating nature of floating interest rates, the monthly installments of a particular amount of loan will vary throughout the entire loan tenure.
- Attributed to the uneven monthly installments, it is very difficult to budget a loan with floating rate of interests.
- Since it is not possible to have a fixed repayment schedule under this interest rate option, it can lead you to pay more than you are comfortable paying. This can, therefore, cause you to have less savings and no budget plan.
Why choose a Floating Interest Rate?
These are some of the scenarios in which a floating rate of interest may be beneficial for you:
- When there are reliable indications that interest rates might decrease in the future.
- This type of interest rate usually suits people who do not possess enough insight regarding the market and, thus, want to stick to the market rates.
Fixed vs Floating Interest Rate FAQs
- Can you shift from a floating rate of interest to a fixed interest rate or vice versa?
- Do NBFCs offer floating or fixed rate of interest on home loans?
- Which is a better type of interest to choose for an older home loan borrower – fixed or floating rate?
- Are both fixed and floating rate of interest available on personal loans?
- Are vehicle loans available with both fixed and floating rate of interest?
Yes, it is possible to switch between floating and fixed interest rates and vice versa. Most lenders charge a nominal conversion fee for this which will be approximately 2% of the loan amount.
NBFCs offer both fixed and floating rate of interest on home loans; however, this depends on the lender.
For people who are older, above the age of 40, there may be up to 20 years remaining on the loan repayment tenure. In such a scenario, it is best analyse how often interest rates may change in the coure of a few decades. If the likelihood of interest rates changing is lower, then it is best to choose a fixed rate of interest for a home loan.
Yes, personal loans have the option of either fixed or floating rate of interest.
Yes, vehicle loans are available with both fixed and floating rates of interest, however, this will depend on the lender.