Struggling to decide between a personal loan with a fixed interest rate and one with a variable interest rate?
It is essential to have all the pertinent information regarding a personal loan before you apply for one, including the rate of interest and its type.
Why is it important to know what kind of interest rate is applicable to your personal loan?
Knowing the multiple advantages and disadvantages of fixed or variable interest rates might help you decide which one could be best for your requirements. Here’s how this will impact your finances –
- It affects how much you will have to pay in terms of interest over the life of the loan.
- Knowledge of the type of interest rate applicable on the loan affects your ability to budget your monthly expenses.
- Knowing the type of interest rate you would want against your personal loan impacts the overall loan amount.
Since a fixed interest rate implies a constant rate throughout the life of the loan, it enables you to budget effectively as the monthly payments are constant.
A fixed interest rate also protects you against rising interest rates in the market.
Although variable interest rates keep changing and make it harder for you to budget your monthly payments, they are usually lower than fixed interest rates at the start of the loan and keep decreasing further over time.
While many individuals are aware of what interest rates are, some need to be made aware that there are two major types i.e. fixed and variable. It is essential to know about them if you want to choose the appropriate loan with the right knowledge.
What is a personal loan with fixed interest rates?
Fixed interest rates occur when a lender maintains a set rate throughout the loan, resulting in a fixed amount of accrued interest.
Personal loans with fixed interest rates guarantee that the interest rate will not change during the term of your loan.
Comparatively speaking, fixed interest rates are greater than variable interest rates.
It also shows the certainty of the precise loan EMIs that you must pay back throughout the term of the loan in advance.
Advantages of fixed interest rate
The advantages of a fixed interest rate are listed below.
- Interest rate – The interest rate is unaffected by market conditions and remains constant for the duration of the loan.
- EMI – Your EMI remains set because this interest rate doesn’t change over time, making it simpler to precisely manage your monthly budget and long-term financial savings or investments.
Disadvantages of fixed interest rate
The following are some disadvantages of a fixed interest rate:
- Typically, a bank or non-bank financing company will offer a variable interest rate that is 1% to 2.5% lower than the fixed interest rate.
- Even if the fixed interest rate declines as a result of a government or Reserve Bank of India (RBI) decision, the personal loans that are already taken out at the prior interest rate are unaffected.
- Even after a rate reduction, the borrower will still be required to make payments at a higher interest rate.
- Frequently, the fixed rate of interest is only appropriate for a short period before it is altered to reflect the current rate.
What is a personal loan with variable interest rates?
Variable interest rates, also known as floating rates, are those that a lender may alter periodically depending on the changes in the repo rate, which is the benchmark set by the RBI.
Personal loans with variable interest rates often signify that, due to different forms of lending rates, the interest rate may change throughout the term of the loan.
You must be ready for any changes in the interest rate during the loan term if you choose a personal loan with a variable interest rate.
Advantages of variable interest rate
The following are some advantages of a variable interest rate –
- Variable interest rates are often set between 1% and 2.5% lower than the fixed interest rate that the same lender is willing to offer.
- A bank or non-bank financing company will typically give its clients lower variable interest rates than fixed rates.
- As a result, even if the variable interest rate rises, it can still be lower than the fixed interest rate that was previously offered.
- If the variable interest rate is higher than the interest rate, it won’t be for the duration of the loan. After some time, there is a probability that the variable rates will decline.
Disadvantages of variable interest rate
The following are the disadvantages of a variable interest rate applicable on a personal loan.
- The monthly payments for a specific loan amount will change for the loan because variable interest rates are erratic.
- Budgeting for a loan with a variable interest rate is particularly difficult due to the unpredictable monthly payments.
- This interest rate option can cause you to pay more than you are comfortable paying because a fixed payback schedule is not attainable. As a result, you can have less money saved and no budget.
Fixed Vs. Variable Interest Rates
|Fixed Interest Rates||Variable Interest Rates|
|The rate of interest is higher.||The rate of interest is lower.|
|Provides a feeling of security.||It helps in the creation of savings.|
|Perfect for the mid to short term.||Suitable for the long term.|
|Fixed monthly payments are made.||The interest rate affects the monthly payments.|
|Simple to budget, plan, and manage finances.||Budgeting and financial planning are challenging.|
|Unaffected by changes in the financial markets.||Subject to changes in the financial market|
Which type of interest rate should you choose?
Although this explanation is basic, it nevertheless holds true in more complex circumstances.
According to studies, a variable rate loan will probably result in the borrower paying less interest overall over time than a fixed rate loan.
Historical patterns, however, don’t always predict future outcomes. The loan’s amortization or EMI schedule must also be taken into account by the borrower.
The bigger the impact a change in interest rates will have on your payments, the longer the amortization period of a loan.
The borrower’s financial situation and choices determine whether a fixed-rate or variable-rate loan is preferable.
Assessing your cash flow, financial flexibility, and security needs should be your first step.
Different people will be in different situations, thus the choice of interest rate can accommodate the borrower’s needs.
When to select a fixed-rate personal loan and when to select a variable-rate personal loan?
In the following situations, you should select a variable or fixed interest rate structure.
Fixed interest rate
- When you prefer stability over the change in the interest rate and lack the knowledge or market experience necessary to predict how the rate will move or the risks involved.
- If you are comfortable paying the current interest rate and want to keep the EMIs fixed.
- If you predict a significant increase in interest rates as a result of an unfavorable market situation.
Variable interest rate
- You are well-versed in the financial market, including the factors that influence interest rate changes.
- There are solid signs that interest rates will decrease in the future and remain stable for the duration of the loan.
- If you predict an increase in income and any increase in interest rates has no impact on your other debts.
Selecting an interest rate structure should be based on your expertise, comfort level, and the benefits that you stand to get from doing so.
It is also wise to get in touch with your lender to find out more.
It helps to determine the maximum loan amount you may be eligible for based on your disposable income, ability to repay, employment, interest rate, and tenure.