Institutions usually charge a fixed interest rate or a floating interest rate on a home loan, business loan or personal loan. Also, along with the interest rate percentage, it is important to keep a check on the type of interest rate (fixed or floating). Fixed interest on loans refers to the interest rate being the same for the entire duration of the loan tenure. While floating interest rate refers to the variable interest rate that changes during the duration of the loan/ debt obligation tenure. This article covers fixed vs floating interest rate in detail.
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What is Fixed Interest Rate?
Fixed interest rate on loans refers to the interest rate being the same for the entire duration of the loan tenure.
What is Floating Interest Rate?
Floating interest rate refers to the variable interest rate that changes during the duration of the loan/ debt obligation tenure.
Fixed vs Floating Interest Rate
Following are the key difference between fixed and floating interest rate.
|Basis of Difference||Fixed Interest Rate||Floating Interest Rate|
|Meaning||The interest rate remains the same for the entire duration of the debt obligation/ loan.||The interest rate changes and is not the same for the entire duration of the debt obligation/ loan.|
|Interest Rate||Higher interest rate. 1-2.5% more than the floating interest rate.||Lower interest rate than the fixed interest rate. However, Higher than the repo rate. Also, the lending institution adds a spread (additional interest) to the repo rate.|
|Monthly Payments (EMI)||EMI is the same for the entire loan tenure.||The EMI and also loan tenure may change with the change in the interest rates.|
|Market Factor||If the interest rates are going to be stable or increase, it’s better to opt for a fixed interest rate loan.||If the interest rates are going to fall, a floating interest rate loan is better.|
|Market Conditions||Not affected by market conditions.||Affected by market conditions.|
|Suitability||Suitable for individuals who wish to have a fixed EMI amount and are not willing to undertake the interest rate volatility.||Suitable for individuals who are willing to undertake the interest rate volatility and also who can adjust their budget with the changing rates.|
|Prepayment||A fixed interest rate scheme may penalise the prepayment of the loan.||Also, a floating interest rate scheme doesn’t penalise prepayments.|
|Financial Planning||Budget planning is possible as EMI and also the tenure are fixed.||Difficult to budget as the interest rates fluctuate.|
|Tenure||Suitable for short to medium tenure (3 to 10 years)||Suitable for long term (20 to 30 years)|
|Risk||Comparatively less risky||Comparatively high risky|