What Are Floating Interest Rates and What Are Their Advantages and Disadvantages?

Getting a loan calls for crucial decision-making skills. Among other things, one must consider interest rates.

Generally speaking, interest rates are pretty high nowadays. Getting a loan at a low-interest rate requires thorough research.

Once decided, the borrower needs to choose from two options: fixed interest or floating interest rates. 

Unlike fixed interest rates, floating interest rates vary throughout the term of a loan. Want to know how? Here’s everything you need to know.

What is a Floating Interest Rate?

An interest rate that varies with the market or is based on an index is referred to as a “floating rate.” Several times during the repayment period, this interest rate may fluctuate.

The base rate, which is the minimum interest rate, is decided by the Reserve Bank of India. The market’s current condition affects the base rate.

Now, the interest rates are also linked to the base rate. The lender determines the interest rate by multiplying the repo rate by the “spread” (extra interest).

The repo rate is the rate at which the RBI lends money to commercial banks.

Any increase or decrease in interest is first passed on to the borrower. Then, they are adjusted to match the loan’s current interest rate.

Floating rates may change often, depending on the terms and parameters of a loan. They could change every quarter, half-year, or annually.

The amount of the EMI will not alter if the interest rate changes at any point throughout the loan’s term. Instead, the floating rate loan’s term is adjustable.

On the other hand, when the floating rate declines, so do the loan terms. According to RBI regulations, lenders cannot impose a prepayment penalty on a loan with a floating rate.

Who Should Opt for a Floating Interest Rate?

When a borrower believes that the base rate will either stay the same or go down over time, a floating interest rate loan is for them. In such cases, he will either benefit from the same rate for the duration of the loan or pay less interest. 

For example, one can benefit from lower rates, until the next RBI revision, if the interest rate is reduced. As a result, low rates make floating-interest loans more alluring than fixed-interest loans.

Additionally, choosing a Flexi loan will enable them to make prepayments. Pay growth, cash bonuses, year-end bonuses, sales incentives, etc. are a few examples. One will be able to pay off the loan more quickly and pay less interest overall as a consequence.

A variable interest rate will be advantageous if one can anticipate having the potential for increased income in the future. In other words, one may pay off his debt more quickly as his earnings rise.

If one is ready to accept interest rate volatility and wants to take advantage of speedier loan payments, floating interest rates could be a major benefit.

Pros of Floating Interest Rates

For the record, floating interest rates come with many benefits, including:

Cheaper

Floating rates are volatile in the short term since they depend so heavily on the market. However, floating rates are less expensive than loans with fixed interest rates in the long run.

With a floating interest rate, there is no maximum hike allowed. Even if interest rates increase by 1% to 2% or more, one will still save more money.

The floating interest rate often changes as rates spike. Simply put, the loan’s duration increases rather than the monthly payment.

Pegged to the Repo Rate

For starters, floating loan rates are closely related to the repo rate. As a result, fixed-interest rate loans are more expensive than long-term loans with floating interest rates.

Moreover, lending institutions also increase the repo rate using “spread.” It is an additional interest charge over and above the repo rate.

No Prepayment Penalty  

RBI rules say that the lender can’t charge fees for loans that are paid off early.

Cons of Floating Interest Rates 

Like everything else on the market, this too has its disadvantages:

Inconvenient

Additionally, it is challenging to keep up with the EMI payments due to fluctuating interest rates. As a result, EMIs with fluctuating rates lack consistency and predictability. 

Financial planning

Due to the erratic nature of interest rates, financial planning is challenging. Unfavorable market circumstances might result in higher premiums, which would be more expensive.

May can be required to pay more than one can manage

With fluctuating interest rates, it is difficult to establish a set monthly payback schedule. Sometimes the EMI amount may be higher than one anticipated or felt comfortable paying.

This may also have a high impact on one’s monthly savings. 

Market conditions affect the interest rate 

The interest rate on loans with floating interest rates is heavily influenced by market circumstances, which are frequently erratic and dynamic. It may do a lot of harm if the interest rate rises to the point that making EMI payments.

It might affect one’s overall credit history. The lender may identify them as a defaulter. If this happens, the chances of getting a loan in the future cease.

Wrapping up 

In a nutshell, interest rates are the most crucial factor that needs to be considered. The decision between a fixed interest rate and a floating interest rate is entirely subjective.

Moreover, before choosing Flexi personal loans or any other loans, remember that they are highly volatile. It will be very difficult to pay off interest if the rate goes up. However, one can benefit from it too. The rates could go down as well. So, there is always a probability of risk that remains.

Lastly, don’t forget to check Piramal Finance for loans at the best interest rate online.