Fixed interest rate on loans refers to the interest rate being the same for the entire duration of the loan tenure. Irrespective of the changes in repo rates by the Reserve Bank of India, the interest rates under the fixed interest rate scheme remain the same. Most borrowers prefer fixed-rate loans because they can easily predict future costs and monthly payments.
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What is a Fixed Interest Rate on Loan?
A fixed interest rate is a rate that is levied on a liability, such as a mortgage, credit card, loan, or corporate bond, at a constant rate. It is applied to the whole term of the loan/ liability or a portion of it.
A fixed interest rate on loans is a type of loan in which the interests remains constant for the duration of the loan. For long-term loans, most borrowers prefer fixed-rate loans. As you can correctly forecast future costs and monthly payments.
In other words, the EMI composition (principal + interest) is the same throughout the loan tenure.
A fixed-rate loan’s interest rate remains constant during the loan’s term. Also, it is unaffected by changes in interest rates or inflation. The term of the loan and the current interest rate will often influence whether or not you choose a fixed-rate loan. The amount for monthly payments increases as the interest rate rises. Fixed interest rates are immune to changes in the economy, but variable interest rates change as the economy grows.
In a rising interest rate regime, fixed interest rate loans are more preferred than floating interest rates. Typically, the interest rates are higher by 1-2.5% than the prevailing floating interest rates.
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Advantages and Disadvantages of Fixed Interest Rate
Following are the key advantages:
- Loan Repayment Amount: The loan repayment amount is constant for a fixed rate loan. Therefore, you can be certain about the repayment amounts.
- Immune to sudden changes in interest rates: You don’t have to worry about the sudden changes in the interest rates, as your loan rate is remains the same. The varying rates will not have any impact on your rate.
- Efficient Financial Planning: Since you know the repayment amounts and tenure, you can plan your finances better.
Following are the disadvantages:
- Potentially higher repayment amounts: When the interest rates are slashed, then you will end up paying higher repayment amounts for your loan. As you have fixed the interest rate at the starting of the loan tenure. Therefore, if the interest rates are lower, you will not be able to take advantage of it. Thus, there are good chances that you will pay high amounts.
- High-interest rates: In comparison to floating interest rates, the fixed rates are higher by 1-2.5%. This is because the lenders factor in the possibility of rising interest rates.
Who Should Opt for a Fixed Interest Rate?
You should opt for a fixed interest rate if you are comfortable with the EMI amount being constant. If you are unwilling to undertake the volatility with the interest rate movements, you can opt for a fixed interest rate. With a fixed-rate loan, you do not have to worry about any surprises or face any difficulty in repayment. Since the EMI amount is constant, you can be well prepared for it. Furthermore, you can also plan your finances better.
Finally, if you like the security of loan payments and do not like any deviations, you can opt for fixed rates. However, it is important to remember that fixed interest rates loans have a higher interest rate than the current floating interest rates.