Floating Interest Rates Vs Fixed Interest Rate

Updated on: 18 Sep 2024

Where do you stand in the floating vs fixed interest rates debate? Confused about why this matters? Deciding between fixed and floating interest rates is crucial as it affects the amount you have to pay as EMIs. Choosing the right type of interest rate allows you to save more on interest payments.

In any discussion about fixed interest vs floating interest rates, you first need to understand them. To understand the meaning and difference between fixed interest rates and floating interest rates, read further.

What is a Floating Interest Rate?

This rate depends on a benchmark rate set by the lender. The EMIs towards your loan repayment will change accordingly. Simply put, it varies as per market fluctuations.

The lenders set a period after which they will revise the rate of interest on your loan. The lender can change these rates annually, half-yearly or quarterly. Note that the EMI amount that you pay monthly remains the same. The lender only alters the tenure according to the changing benchmark rate.

Benefits of Floating Interest Rates

If you decide to go with these rates, you get to enjoy the following benefits:

Floating rates are generally lower than the fixed rates. So, you stand to save on your total cost of borrowing.
If the lender makes a downward revision to the benchmark rate, you stand to gain from the reduced interest payments and shorter loan tenure.

Drawbacks of Floating Interest Rates

There are also certain disadvantages to consider:

As the interest rate fluctuates according to market conditions, this lending option is considered unstable.
In a low-inflationary market, the floating interest rates can remain high for a long time. This can burn a hole in your pocket.

What is a Fixed Interest Rate?

This interest rate is fixed at the time of your loan agreement and remains unchanged throughout your repayment duration. However, lenders generally peg it at 1%-2% higher than the prevailing benchmark rates.

As opposed to floating interest rates, you can not avail yourself of reduced interest payments when the repo rate lowers. However, it provides a sense of certainty as your interest outgo also remains unchanged through the tenure.

Benefits of Fixed Interest Rates

When you choose a loan with this rate, these are the benefits that you enjoy:

Fixed interest rate offers predictability and certainty about the interest amount that you need to pay and the tenure you have for repayment
Fixed interest rates become a more viable option when the repo rate is low
This type of interest also allows you to calculate the overall cost of your borrowing with ease

Drawbacks of Fixed Interest Rates

Similar to floating interest rates, these rates have some drawbacks:

As opposed to the floating interest rates, you do not benefit even if the repo rate lowers.
A fixed interest rate is generally higher in comparison to floating interest rates.

Difference Between Fixed and Floating Interest Rates

Here are a few points of difference to consider when comparing floating vs fixed interest rates:

Basis of Difference	Fixed Interest Rate	Floating Interest Rate
High/Low	These are comparatively on the higher side	These rates are generally lower
Number of EMIs	It stays fixed as the loan tenure doesn’t change	It may change with any fluctuation in the tenure due to changes in rates
Market Fluctuations	They don’t change with market fluctuations	They fluctuate with changes in the market
Ideal For	These are a good option for short and medium-term loans	These are ideal for long-term loans
Financial Management	Planning and management of finances is easy since the interest amount remains the same	Planning and managing the budget is difficult since the interest amount is subject to change

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FAQs on Fixed vs Floating Interest Rates

Which is better among fixed vs floating interest rates?

It depends on your needs and preferences:

If you are looking for stability, a fixed interest rate is the perfect option for you
If security is not your prime consideration, you can go with the floating interest rate

Do market conditions affect fixed and floating interest rates?

The RBI periodically revises the repo rate based on market conditions. While they affect the floating rates, they bear no effect on the fixed rates.

Can I switch from a fixed interest rate to a floating interest rate?

Yes. Some lenders allow you to shift to floating rates after paying some EMIs.

How do the floating interest rates work?

Repo rates and floating interest rates are directly related. When the repo rate goes up, the floating interest rates also spike and vice versa. So, if the rates go up, the tenure may increase, and if they go down, the tenure may decrease.