New Delhi [India], September 10: While applying for a personal loan, borrowers focus on the loan amount, repayment tenure and EMI. But the most important factor that determines your total borrowing cost is the interest rate. The interest rate determines how much EMI you are going to pay and for how many years.
Majorly, lenders offer two types of interest rates on personal loans: fixed and floating interest rates. Both are different, and understanding them can help you make a better borrowing decision. In this blog, you will get complete knowledge about both fixed and floating interest rates.
What is a Fixed Interest Rate?
A fixed interest rate means the interest rate will remain the same throughout the loan tenure. It won’t change. This means the interest rate, which is mentioned at the time of signing the loan agreement, will remain the same no matter what happens in the economy.
The borrower here will pay the fixed EMI throughout the loan tenure, as there are no changes in the rate due to market conditions. As the EMI remains unchanged, borrowers can plan their monthly budget more efficiently. The fixed interest rate is generally higher in the initial years.
Benefits of Fixed Interest Rates
● EMI remains the same throughout the tenure. This provides you with clarity on monthly payments.
● Borrower knows exactly what they have to pay each month. Hence, they can do proper planning accordingly.
● If the market interest rate increases due to economic conditions or due to RBI decisions, then borrowers remain protected as the loan interest rate won’t change.
Limitations of Fixed Interest Rates
● You don’t get any advantage from the decline in market rates.
● The interest rate will be slightly higher in the initial years.
● Some lenders may have restrictions on switching to another interest structure.
What is a Floating Interest Rate?
In a personal loan, the floating interest rate means the interest rate that fluctuates or changes during the loan tenure. The rate is not fixed and is linked to a benchmark rate set by the lender. Benchmark rate can be the repo rate set by the RBI. The loan interest rate can increase or decrease with changes in the benchmark rate and economic factors.
For example, if the RBI increases the repo rate, the bank will often increase its lending rate; as a result, the floating rate will go up. Whereas if the RBI reduces the Repo rate, then your floating rate also reduces.
Benefits of Floating Interest Rates
● If the market rate reduces, then your interest rate will also reduce. This will reduce monthly payments and save a lot of money.
● The floating rate starts at a lower interest rate in the initial years.
● Lower interest rates can reduce the overall repayment amount.
Limitations of Floating Interest Rates
● Monthly EMI can increase if the market rate rises.
● With a change in EMIs, budgeting becomes tough.
● Total loan cost can increase if the market rate increases.
Difference Between Fixed and Floating Interest Rates
By a proper understanding of the difference between fixed and floating interest rates, one can choose the option that suits them more. Here is the table that depicts the difference between fixed and floating interest rates: –
| Parameter | Fixed Interest Rate | Floating Interest Rate |
| EMI Stability | EMI doesn’t change throughout the loan tenure. | EMI can change during the loan tenure if there are changes in the benchmark rate. |
| Interest Movement | Interest remains unchanged | It can change with market conditions. |
| Risk Level | Risk is low as the EMIs are predictable. | There is a higher risk involved as there is unpredictability about EMI. |
| Initial Rate | Is slightly higher. | It generally starts with a lower rate |
| Benefit from the rate fall | There is no such benefit as the rate remains the same. | The repayment amount can decrease. |
| Market Impact | Interest rate is not affected by the market conditions | Interest rates are linked to market conditions. |
| Long-term cost | You know in advance the total cost of borrowing. | The total cost of borrowing can increase or decrease. |
| Budgeting | Budgeting becomes easy as EMI remains fixed. | Budgeting is more challenging as it requires flexibility. |
Which Option is Better for You?
What to choose between fixed and floating interest rates for personal loans depends on your financial condition.
A fixed interest can be suitable if: –
● You want fixed EMIs.
● You have a fixed monthly income.
● You want certainty in financial planning.
● The market trend represents a rise in interest rates.
A floating rate may be suitable if: –
● You can manage change in EMIs
● You are willing to take risks to save money.
● The market trends represent a fall in interest rates.
● You are comfortable with some uncertainty.
Conclusion
Having a clear understanding of fixed and floating interest rates for personal loans is important for borrowers. This is because it affects the loan repayment journey and total repayment cost. A fixed interest rate remains unchanged throughout the tenure, whereas a floating interest rate can fluctuate over time.
Both options have their own benefits and limitations. You shall select the one that suits your financial condition and risk appetite. Borrowers who want stability opt for a fixed interest rate. Whereas those who are comfortable with market fluctuations and want savings go for floating interest rates.
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