Fixed vs Floating Interest Rate

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.
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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

  1. Can you shift from a floating rate of interest to a fixed interest rate or vice versa?
  2. 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.

  3. Do NBFCs offer floating or fixed rate of interest on home loans?
  4. NBFCs offer both fixed and floating rate of interest on home loans; however, this depends on the lender.

  5. Which is a better type of interest to choose for an older home loan borrower – fixed or floating rate?
  6. 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.

  7. Are both fixed and floating rate of interest available on personal loans?
  8. Yes, personal loans have the option of either fixed or floating rate of interest.

  9. Are vehicle loans available with both fixed and floating rate of interest?
  10. Yes, vehicle loans are available with both fixed and floating rates of interest, however, this will depend on the lender.

News About Fixed vs Floating Interest Rate

  • Lakshmi Vilas Bank to Introduce New MCLR From 1 September 2018

    According to the recent reports, Lakshmi Vilas Bank has announced on 31 August 2018 to revise its Marginal Cost of funds-based Lending Rate (MCLR) effective from 1 September 2018. On 6 September, the bank observed a technical error in the computation of the MCLR. However, the rates have been revised afterward with effect from 1 September 2018. The overnight MCLR offered by Lakshmi Vilas Bank currently stands at 9.10% p.a. while the one-month MCLR is at 9.15% p.a. The 3-month MCLR that the bank is currently offering is 9.30% p.a. and the 6-month MCLR is at 9.45% p.a. The 1-year MCLR of Lakshmi Vilas Bank has been revised to stand at 9.75% p.a.

    14 September 2018

  • Karur Vysya Bank revises MCLR

    Karur Vysya Bank has revised the MCLR of the Bank and will be implemented starting August 07, 2018. This is after the Reserve Bank of India decided to increase the marginal cost of fund-based lending rate by 25 basis points in the third bi-monthly monetary policy statement for 2018-19. The lending rate now stands at 6.50 percent. The overnight MCLR and the one-month MCLR now stands at 8.55%. The three month, six month, and one year MCLR currently stand at 8.90%, 9.35% and 9.55% respectively.

    10 August 2018

  • Rs.10,000 crore G-secs purchased by RBI through OMO

    The Reserve Bank of India (RBI) has announced the purchase government securities (G-secs). The purchase has been made under Open Market Operations (OMO). The move was made after the assessment was made by the Reserve Bank of India of the prevailing liquidity solutions. The Reserve Bank of India is now planning to raise Rs.10,000 crore on 19th July. The bank is planning to do the same by multi-security auction which will be done using multiple price method. Security wise breakdown has not been provided by the bank yet. The announcement of results of the auction results will be made on the day of the issue. Participants should ensure that requisite amount of securities are available on their SGL on July 20 by 12 noon.

    19 July 2018

  • Fund management to be improved by RBI’s proposals on large loans

    A SBI study has said that the draft guidelines on loan system for delivery of bank credit made by the Reserve Bank of India will be very helpful in improving the intra-day fund management and liquidity planning by large borrowers. The draft made by the RBI specifies a minimum level of ‘loan component’ and a Credit Conversion Factor (CCF) that is mandatory. Borrowers are now required to manage short term liquidity and the working capital cycle. This move will also lead to the improvement in the management of short term and intra-day liquidity by banks. There is also a possibility for the development of term money market due to the withdrawals by customers under Working Capital Demand Loans.

    19 June 2018

  • MCLR rates raised by 5 bps by Syndicate Bank

    Syndicate bank has raised the marginal cost of funds based lending rate(MCLR) by 5 basis points(bps). The six month MCLR rate has now raised to 8.3 percent and the revised one-year MCLR rate now stands at 8.5 percent. The bank has said that the revised minimum lending rates will be effective from May 10.

    24 May 2018

  • All India Bank Retirees Federation has requested revised pension for bank retirees

    Although the inflation has gone up 10 times in the last 20 years, the basic pension for retired bank employees has not been revised since then. Therefore, the All India Bank Retirees Federation (AIBRF) has demanded that the union government look into revising the basic pension for bank retirees. As of now, the family pension in banking is 15% whereas in the government and RBI, it is 30%. In addition to revising the basic pension and raising the amount of family pension, the government has been requested to resolve all the pending issues.

    According to Mr. Deshpande, the President of AIBRF, the consolidated sum in pension funds of various banks is above Rs.12 lakh crore and has been increasing every year. Therefore, it should be easier for the banks to fulfill the demands of the AIBRF. There will likely be an increase in non-performing assets (NPAs) if the banks were privatised, according to S.C. Jain, the General Secretary of AIBRF. As it is, the banking sector is facing issues with growing NPAs at Rs.10 lakh crore which mostly belongs to corporate sectors.

    6 April 2018

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