Fixed Vs. Floating Rate of Interest

Fixed-and-floating-interest-rate_loanbaba

Applying for a loan is one of the biggest financial decisions you will make. A loan impacts various areas of your life and requires careful planning and management of your finances. Of all the factors considered while applying for a loan, rate of interest is the most carefully considered components in loan applications. After all, it is the cost of borrowing money from a lender. It has acquired a reputation since it is affected by, and influences, a lot of factors such as type of loan, tenure, age, and EMI.

When applying for a loan, borrowers are faced with two main types of rates of interest:

  1. Fixed Rate of Interest
  2. Floating Rate of Interest

The fixed rate of interest, as the name suggests, is the type of interest that remains fixed. Usually, lending institutes allow the rate of interest to remain fixed for certain duration, post which it turns to floating rate of interest (explained below). For the duration that the interest rate remains fixed, the borrower can continue to pay according to the contractual (lower) interest rate. This is the biggest advantage of this type of interest, that the rate remains constant despite the fluctuations in repo rate. Thus, it protects you against volatile fluctuations. But on the flipside, if the repo rate decreases, the borrower needs to continue paying the agreed (higher) rate of interest.

The floating rate of interest is quite opposite to this. A floating interest rate changes according to the changing repo rate. At the time of signing the loan agreement, the floating rate of interest is, comparatively, lower than fixed rate of interest. This is because floating rate of interest is influenced by the repo rate all through the loan tenure. One of the main advantages of floating interest rate is that it remains low during low inflation period. It also means that you pay lower EMI every month. However, when the repo rate rises, so does your interest rate and, in turn, the EMI.

Let us look at amortisation charts for both types of interest rate in order to understand how each of them has an impact on the EMI paid each year.

Amortisation chart for Fixed Rate of Interest:

Tenure (in years) (Fixed) Rate of Interest Outstanding Balance Principle (each year) Interest (Each Year) Total Payment (each year)
10,00,000 (loan amount)
1 10% 969,683 30,317 98,635 128952
2 10% 936,191 33,492 95,461 128953
3 10% 899,192 36,999 91,954 128953
4 10% 88,080 40,873 88,080 128953
5 10% 813,166 45,153 83,800 128953
6 10% 763,285 49,881 79,072 128953
7 10% 708,181 55,104 73,848 128952
8 10% 647,306 60,874 68,078 128952
9 10% 580,058 67,249 61,704 128953
10 10% 505,767 74,291 54,662 128953
11 10% 423,697 82,070 46,883 128953
12 10% 333,033 90,664 38,289 128953
13 10% 232,876 100,157 28,795 128952
14 10% 122,231 110,645 18,308 128953
15 10% 0 122,231 6,722 128953
Total 10,00,000 9,34,291 19,34,291

Amortisation Chart for Floating Rate of Interest:

Tenure (in years) (Floating) Rate of Interest Outstanding Balance Principle (each year) Interest (Each Year) Total Payment (each year)
10,00,000 (loan amount)
1 9% 966,947 33,053   88,659 1,21,712
2 9% 930,793 36,154 85,558 1,21,712
3 9% 891,247 39,546 82,166 1,21,712
4 10.5% 852,056 39,191 91,730 1,30,921
5 10% 807,232 44,824 83,188 1,28,012
6 9.5% 756,399 50,833 74,511 1,25,344
7 9.5% 700,521 55,878 69,466 1,25,344
8 10% 640,305 60,216 67,342 1,27,558
9 11% 575,997 64,308 67,255 1,31,563
10 9% 500,168 75,829 48,762 1,24,591
11 9% 417,225 82,943 41,649 1,24,592
12 9.5% 327,226 89,999 35,785 1,25,784
13 9.5% 228,294 98,932 26,852 1,25,784
14 9% 119,261 109,033 16,122 1,25,155
15 9% 0 119,261 5,894 1,25,155
Total 10,00,000 8,84,939 18,84,939

When you compare both the charts, two things stand out:

-The EMI remains constant, year to year, with the fixed rate of interest

-The total amount paid towards the loan is lower with the floating rate of interest.

Thus, while the EMI for floating interest rate varies significantly each year, you do pay lesser amount towards your loan. But with a fixed rate of interest, you can predict your EMI and manage your monthly finances better. In conclusion, it is advised to carefully assess all the factors before you decide upon a particular type of interest rate.

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