Fixed or Floating rate of interest, What does it mean, and which is better?
Hello everyone and welcome to our blog, have these questions crossed your mind too –
- Floating or fixed rate, which rate of interest is better?
- In case of an increase in interest rate, whether my EMI will increase or tenure will increase etc.
So in this blog, we will understand in depth what these terminologies are and what type of rate, fixed or floating is suitable for you.
Floating Rate
These are known as adjustable rate loans and are linked to the bank’s benchmark rate which is usually the Prime rate or RBI’s base rate, which moves in proportion with the market condition, due to the changes in the benchmark rate, the floating rate of interest also changes.
Limit for floating rate of interest
There are certain caps and floors which are applicable in case of a floating rate of interest which means the loan will not go above and below a certain rate, to protect you as well as the bank’s interest.
For example – if you have taken a loan at 9% and there is a cap and floor of 2%, then your interest rate will not go above 11% and below 7%. Hence you should always confirm from your bank how high and low your interest rate can move.
When are interest rates revised in case of a floating rate of interest?
Usually, it is at the discretion of the bank, when to revise the rates, it may be annually, half-yearly, quarterly or it may also be your loan anniversary.
Tenure will increase or EMI will increase, in case of an increase in interest rate for floating rate of interest?
Usually, in case of an increase in interest rate, the bank does not increase your EMI amount because it will affect your pocket, on the other hand, what bank do is, increase your tenure of the loan. But on your request banks can increase your EMI too rather than increase the tenure. And vice versa in case of a reduction in interest rates.
Who should opt for a floating rate of interest?
- Those who are expecting interest rates to fall.
- Those who are uncertain about it, but are willing to take the risk, that their EMI may increase or decrease
- Floating interest rates are marginally lower than a fixed rate and hence can provide you with immediate saving.
Fixed Rate
One basic thing which we all know about the fixed rate of interest is, no matter what the market circumstances are we will pay a constant rate of interest over the term of the loan. But one big disadvantage is the rate of interest in the case of a fixed rate is marginally higher compared to the floating rate of interest.
Now the question is who should opt for a fixed rate of interest?
- Those who are comfortable with the same amount of EMI lifetime
- You believe that interest rates will rise in the future, depending on the market scenario. But one big question here is How to analyze it? The simple answer to this question for a common man is to ask the banker, agent, or your CA about the rise and fall in interest rates over the past few years and based on that data you can take your decision.
Can you change from a Fixed rate of interest to a floating rate of interest and vice versa?
The answer to this question is YES, banks give you the option to shift from a floating rate of interest to a fixed rate of interest and vice versa, but the catch here is banks will charge fees that may range up to 2% or more.
Example – Assume you have taken a loan of 30 Lakh, then in case of change, you will pay an amount of 60,000/- or more which is not a small amount, hence choose wisely before selecting your rate.
Hybrid model
If you are still unsure, what kind of interest rate is suitable for you, you can choose a combination in which for the first few years you will get a fixed rate and after that, it will change to a floating rate of interest. But before choosing it, keep in mind the advantages and disadvantages which I have mentioned above.