Understanding The Difference Between Fixed and Variable Interest Rates In Personal Loans

Personal loans can be easily availed from formal lending institutions like banks and non-banking finance companies. Most borrowers can get money within a matter of a few days. In fact, most banks also give a pre-approved personal loan to their existing customers, often at a relatively lower interest rate. Banks have insights of the customer’s credit history and spending pattern.

Using data analytics a pre-approved personal loan is given at an attractive rate. This is important because personal loans are unsecured in nature, which means lenders do not ask for any collateral. But this also means that interest rates on personal loans are also high compared to home or vehicle loans. Personal loans are also given based on the creditworthiness of the borrowers. Hence, credit score comes into the picture. Those with good scores are able to still get a better deal but for others, it could mean even higher cost of borrowing money from lenders. Best part is that banks and lenders like IIFL Finance have made the process of applying for personal loans hassle free and transparent.

Personal loans are priced either on fixed interest rate or floating interest rate. The monthly repayment or the EMI, which includes principal as well interest cost, will depend on whether personal loan is on fixed or floating rate. One of the biggest differences between the two is the EMI amount. In fixed rate, EMI amount will remain constant through the life of the loan. That is till the last EMI, the same amount will be repaid. In case of floating or variable rate, EMI amount could change because it ultimately depends on the market conditions and other benchmarks.

Let’s understand more about fixed and floating rate personal loans –

Fixed Rate Personal Loans –

As the name suggests, the interest rate at which you had taken the loan remains the same and does not get impacted by the fluctuations by the changes in the interest rate in the economy. In addition to the borrower’s creditworthiness, banks also consider their borrowing costs, mainly interest paid to depositors, and other operational costs for arriving at an interest rate. But the change in the Reserve Bank of India’s repo rate, which influences all other interest rates across financial products, also impacts the loan pricing by banks. In case of a fixed rate personal loan, changes in the repo rate do not make any difference.

What Are The Benefits Of Fixed Rate Personal Loans –

Predictability –

Since EMI amount remains the same through the tenure of the personal loan, it helps in better financial management as part of the monthly income will be kept earmarked for loan repayment.

Flexibility In Budgeting –

Because the EMI on personal loan is fixed, borrowers have a greater flexibility in making a household budget, including spending on essentials as well as leisure such as eating out, going for a weekend trip, etc.

Protection From Future Interest Rate Hike –

Adverse economic conditions could lead to a spike in interest rate in the economy. Having fixed rate loans, protects in such a scenario and borrowers continue to repay the same amount.

Variable Rate Personal Loan –

Or floating rate personal loans are linked to various benchmarks. The benchmark is either linked to external benchmarks such a RBI repo rate or arrived through a mix of lenders’ borrowing and operational cost. Now, the final interest rate is arrived at by adding a spread over the benchmark. The spread depends on the credit history of the borrowers. Since these benchmarks are subject to reset at specific intervals, EMI on variable rate or floating rate loans also changes. Banks price some retail loans on external benchmarks such as RBI repo rate. Now, if RBI hikes repo rate by 50 basis points, the interest rate on loans priced on the external benchmark will also increase by the same quantum. However, the lenders will take a call on whether or not to change the spread depending on the borrower profile.

What Are The Benefits Of Variable Rate Personal Loans –

Current Interest Rate –

In variable rate personal loan, the pricing is based on the current interest rate prevailing in the market.

Upside From Rate Cuts –

When the RBI cuts the repo rate, borrowers will benefit from the lower interest rate. Borrowers keep aside a certain portion of monthly income on loan repayment. In case of the cut in variable rate personal loan, the EMI will come down, possibly below the budgeted EMI amount. If it remains lower, the savings made could be used for prepayment on loans.

No Charge On Prepayment –

Borrowers have the option to lower the debt burden by prepaying personal loans, either entirely or partly, before the end of the loan tenure or the last EMI. While lenders charge a prepayment penalty, the RBI has barred them from levying such penalty in case of floating rate personal loans.

Conclusion

Personal loans priced on fixed as well as variable interest rates have own advantages. Choosing between the two interest rates must be based on the borrower’s current net monthly income, projected pay rise, emergency corpus, and other expenses. Borrowers must also compare interest rates on personal loans across various lenders.

IIFL Finance has displayed all the relevant information on personal loans such as interest rate, eligibility, amount that can be availed, repayment tenure, etc. Applying for personal loans at IIFL Finance is easy and the entire process can be completed online.