How Does a Floating and Fixed Rate of Interest Work?
January 18, 2023

Economies today are fuelled by Lending; the RBI (Reserve Bank of India) allows Banks and NBFC to fund further but regulates the cost of funds needed to enhance growth and control inflation. Hence, rising inflation governing bodies will increase interest rates, whereas table inflation will decrease lending rates.

Banks and financial institutions establish their rate list per the cost of funds with added margins and offer Secured and Unsecured credit to credit seekers as;

Personal Loans
Business Loans
Home Loans
Vehicle Loans
Loan Against Property

Borrowing comes at a cost; the principal charge to be paid by the borrower is the interest rate at which the funds are forwarded for the term or Tenure of the Loan. The Interest rate is the amount charged over the principal by the lender.

Will You Be Charged a Floating or Fixed Interest Rate for Your Loan?

Keeping in mind the fluctuations in the Base rate of the RBI Banks adjust interest rates accordingly holding the margins of the Bank steady. The changes most affect secure loans with extended tenures, primarily Mortgages for which the interest will be charged at a Floating rate. At the same time, Banks offer a fixed interest rate for limited-tenure loans.

What is a Floating Rate of Interest?

A Floating Interest Rate, as the term denotes, is a variable rate that fluctuates as per the base rate. The base rate is the rate the Federal Reserve or Reserve Bank of India will charge commercial Banks for further lending. Lenders can further publish their rates taking into account their cost of funds.

With a change in the base rate, and MCLR, the Floating Interest Rate will also fluctuate the EMI, and the monthly equated instalment will increase or reduce accordingly. Therefore a floating interest rate is usually reviewed every quarter, and the instalment changes will be affected.

A Floating Rate in interest is applied to Home Loans and Loan Against property, high-value loans allotted for increased tenures up to 25 years/300 months. Economic changes will affect long-term loans, and the lending rate will be adjusted.

Applicants can pay a fixed Interest Rate for mortgages for a limited period the fixed rate will be higher than the current Floating Interest Rate. The rate will be reviewed and adjusted according to the ongoing Rate of Interest.
The advantage of a floating interest rate is that it moves in tandem with the economy, providing relief to the customer with a lower instalment with rising inflation. In addition, refinancing a mortgage is also an option with the lowering of interest rates.

What is a Fixed Interest Rate?

Unsecure loans and short-tenure loans, such as Personal Loans, Vehicle loans, gold loans, and finance for commodities are forwarded at a fixed interest rate.

A fixed interest rate remains steady throughout the tenure and the EMI remains unchanged. It is not affected by changes in the MCLR and market fluctuations, as is a floating rate; it remains constant.

A fixed Interest rate is determined at the time of disbursal of the loan the loan agreement will reflect the details of the interest rate charged, the tenure for repayment and the EMI. The EMI will be presented to the Bank month on month through ECS.

The EMI will be deducted from the Bank account on a fixed date; this date remains unchanged for the entire tenure of the loan, and the instalment amount will be deducted from the account through ECS (electronic clearing systems.)
The advantage of a fixed interest rate is that there is no ambiguity regarding the total cost of the loan and the customer can plan the budget for the repayment tenure.

A fixed or floating interest rate is applied per the terms and conditions of the lender as per the governance of the Reserve Bank of India. The applicant has no choice but to go with the dictate though it always benefits the customer to know details of all the costs and charges and how they will be applied to the credit taken.

The Interest Rate is the primary charge understanding the nuances of how it works and how to calculate your Interest Rate is essential. Our EMI calculator is a tool to help you know your EMI as per the Interest Rate and tenure applicable.

While borrowing, it is essential to know the costs and terms to check on the bandwidth to bear the cost of credit, as timely payments are a priority to maintain a good credit profile and CIBIL score this will go a long way to ensure availability and smooth process of further credit when required.

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