As you apply for a personal loan or any other type of loan, you should pay attention to important factors, like the loan amount, the interest rate, the repayment tenure, and additional charges offered by the lender or the NBFC. While applying for a personal loan, most of us skip checking the type of interest rate being applied – whether it is fixed or floating.
It is important to understand the difference between fixed and floating interest rates for personal loans as they impact the loan EMIs. This knowledge also helps you with proper repayment planning as you decide on the best way to repay the loan amount.
Understanding Fixed and Floating Interest Rates
Within a fixed lending setup, the interest rate is charged at a fixed or constant rate for the entire tenure of the personal loan. When you choose the option of a fixed interest rate on a personal loan, the interest accrual will remain the same for the entire loan tenure.
Borrowers are able to analyze their fixed monthly EMIs in a convenient fashion. Moreover, it is also possible to plan out the finances effectively. However, fixed interest rates are typically set at a higher margin of around 1-2 percent when compared with flexible interest rates.
In case of the floating interest rate, also known as the variable interest rate, the rate of interest is variable and remains subject to periodic revisions that align with the changes in the repo rate. It is the lending benchmark that is set by the RBI.
With a floating interest rate, lenders impose a margin or spread on the repo rate while determining the interest rate, referred to as RLLR or Repo Linked Lending Rate. When the repo rate changes, the same is reflected in the interest rate as well.
How Do Fixed and Floating Interest Rates Impact Loan Repayment?
A fixed interest rate on the personal loan remains constant throughout the loan term. This ensures monthly repayments that are easily predictable. With this stability, borrowers are able to indulge in effective financial planning as the interest rate will not be affected by changes in the market.
On the other hand, the floating interest rate tends to vary depending on the market conditions. In case the interest rate will reduce, the borrowers will have to pay less interest. In turn, this minimizes the overall loan cost.
Pros and Cons of Fixed Interest Rates
Pros:
- The interest rate remains fixed throughout the loan term. This remains the same irrespective of any changes in the market conditions.
- The EMI value of the loan does not alter. In turn, this offers stability with respect to budgeting and cash flow management.
Cons:
- Higher interest rates.
- There is no benefit obtained from interest rate drops.
Pros and Cons of Floating Interest Rates
Pros:
- Floating interest rates typically start on the lower spectrum in comparison to the fixed interest rates. This helps in saving significantly on the entire loan amount.
- Floating interest rates adjust according to market conditions. This offers the chance to ensure reduced repayments when market rates will drop.
- Floating interest rates are ideal for those who are able to manage fluctuating EMIs.
Cons:
- There remains a situation of uncertainty in repayments due to the overall variability.
- In case the market interest rates rise, borrowers will have to face higher repayment amounts.
Key Factors to Consider When Choosing Between Fixed and Floating Interest Rates
1. Loan Tenure: When you choose the option of a short loan tenure, a variable or floating interest rate will be more effective. This is because it allows you to take advantage of interest rate drops in the market. For long-term loan tenures, you can choose fixed interest rates.
2. Risk Tolerance: Fixed interest rates are ideal for those who prefer peace of mind and do not want to indulge in market uncertainties. On the other hand, if you have an appetite for taking risks, you can choose the option of floating interest rates.
3. Financial Goals: If you wish to ensure financial certainty, you should choose fixed interest rates for your personal loans. On the other hand, variable interest rates are attractive to those who wish to attain potential savings while managing EMI fluctuations.
Which Interest Rate Option is Best for You?
Making the selection between fixed and floating rates of interest for a personal loan will depend on specific factors, like the loan tenure, your financial goals, and risk tolerance. If you prefer stability and peace of mind, you can choose fixed interest rates offering predictable payments. However, if you wish to take some risk to save significantly, you can choose floating interest rates for your loan application.
Conclusion
While choosing a personal loan, it is important to understand the difference between a fixed and floating interest rate for your loan application. With Stashfin, you can make an informed decision based on your financial goals and market expectations. The right choice will ultimately depend on your individual needs.
Frequently Asked Question
Can I switch from a fixed to a floating interest rate during my loan tenure?
Yes. Many lenders allow you to switch from a fixed to a floating rate of interest during your loan tenure. However, this could incur additional charges or processing fees.
Do banks charge higher interest for fixed-rate personal loans?
Yes. When it comes to fixed-rate personal loans, banks charge a higher rate of interest. This is because these loans offer peace of mind and financial stability.
How often do floating interest rates change?
Typically, floating interest rates tend to change every 3 to 6 months. The variation will ultimately depend on factors like the market conditions and the lender’s policies.
Which is better for a long-term loan: fixed or floating?
If you apply for a long-term loan, it is advised to choose the option of a floating interest rate. This option could lead to major savings in the long run.
Do all lenders offer both fixed and floating interest rates?
No. Not every lender will offer the option of both fixed and floating interest rates. You should check with the lender beforehand to come across the available options.