Borrowers often get confused between fixed and floating interest rates when applying for a personal loan. The choice of interest rate affects two critical financial aspects, the amount of EMIs payable and repayment planning.
One must, therefore, understand the difference when assessing fixed vs floating interest rates on advances such as personal loans to decide on a suitable option.
Under a fixed lending facility, the interest is charged at a constant rate for the entire loan tenor. When opting for a fixed interest rate, the interest accrual throughout the tenor remains constant.
Borrowers can assess their fixed monthly outgoes as EMIs conveniently under a fixed rate of interest and plan their finances accordingly. These interest rates are, however, usually set at a higher margin of 1 to 2% as against flexible rates.
While it can be detrimental in the case of long-term loans, borrowers of short-term advances such as personal loans can benefit as there are no periodic revisions and the total repayment liability remains constant.
Under the floating interest rates (also known as variable rate of interest), the interest rate is subject to periodic revisions at par with changes in the repo rate, a lending benchmark set by the RBI.
Lenders add a spread or margin to the repo rate and determine the interest rate known as RLLR or Repo Linked Lending Rate. Any change in the repo rate also purports a change in the interest rate applicable to loans and advances extended to borrowers.
Although the EMIs for such loans may remain unchanged, interest rate adjustments under floating lending rate variant can extend the loan tenor due to an increase in the total repayment liability.
A decision regarding the fixed or floating interest rate which is better, however, rests on the borrower.
Given below are scenarios that can help you decide between fixed vs variable interest rate.
It is ideal to opt for a fixed lending rate under the following circumstances –
Fixed rates of interest allow for better financial planning as the repayment tenor remains unchanged.
Choosing the better alternative between fixed and floating interest rates depends on your suitability when applying for a loan. Opt for an interest rate conversion against a nominal fee payment if the benefits of one lending rate override those of the other.