Pros and cons of fixed and floating interest rates

Borrowers often find it difficult to choose between fixed and floating interest rates when applying for a personal loan. This decision directly affects two important aspects of borrowing: the monthly EMI amount and long-term repayment planning.

Understanding the difference between fixed and floating interest rates is therefore essential before finalising a personal loan, as it helps borrowers select an option that suits their financial stability and risk comfort.

Under a fixed interest rate loan, the rate of interest remains unchanged for the entire loan tenure. Once the loan is sanctioned, the interest charged does not fluctuate with market movements or changes in lending benchmarks.

With a fixed rate of interest, borrowers can easily calculate their monthly EMIs in advance and plan their finances with greater certainty. However, fixed rates are generally priced slightly higher, usually by around 1 to 2%, compared to floating rates.

While it can be detrimental in the case of long-term loans, borrowers of short-term advances, such as personal loan benefit as there are no periodic revisions and the total repayment liability remains constant.

Before proceeding, it can be useful to check your pre-approved personal loan offer to understand the interest options available to you.

Floating interest rates, also known as variable interest rates, are linked to external benchmarks such as the repo rate set by the Reserve Bank of India. These rates are revised periodically based on changes in the benchmark.

Lenders add a fixed margin or spread over the repo rate to arrive at the applicable lending rate, commonly referred to as the repo linked lending rate (RLLR). Any change in the repo rate results in a corresponding change in the loan’s interest rate.

In floating rate loans, EMIs may remain the same initially, but an increase in interest rates can extend the loan tenure and raise the total interest outgo. Conversely, rate cuts can reduce overall repayment costs.

Choosing between a fixed or floating rate ultimately depends on the borrower’s financial outlook, income stability, and risk tolerance.

It is ideal to opt for a fixed lending rate under the following circumstances:

• When borrowers wish to maintain their total repayment liability and EMIs as assessed initially and want no changes in their repayment schedule.
• If they are not ready to take risks associated with changes in market trends regarding lending rates.

Fixed rates of interest allow for better financial planning as the repayment tenor remains unchanged.

Floating rates of interest can be suitable if:

• Borrowers perceive a trend of repo rate cuts. It keeps the repayment liability in check as interest accrual reduces over time.
• They see a potential of increase in income. Opting to pre-pay your loan liability can help save significantly both on the total repayment amount and pre-payment fees.

Before finalising your choice, it helps to check your eligibility for personal loan and assess which interest structure aligns better with your repayment capacity.

Selecting the right interest rate option can significantly influence your borrowing experience. Some lenders also allow interest rate conversion during the loan tenure for a nominal fee, if the alternate option becomes more beneficial later.

Read more: Differences between flat and reducing interest rate