Floating Interest Rate

Floating Interest Rate - Meaning, Pros & Cons, and How Does It Work?

July 25, 2023 • 1070 views

Wondering if you should get a loan at floating interest rates? Before finalizing, it becomes imperative to know how it functions and the advantages and disadvantages present. This will help you make the best decisions regarding it. Go through this guide to learn what are floating interest rates, weigh the pros and cons, and understand the mechanics behind it.

What is a Floating Interest Rate?

A floating interest rate is an interest rate that fluctuates based on prevailing conditions in the market. Factors like market conditions and benchmarks influence how much borrowers will pay as EMI to repay the credit. 
Borrowers with a floating interest rate have different monthly payments and overall costs throughout their loan or mortgage. Understanding the loan agreement terms is important to know when and how the interest rate can change.

How Does Floating Interest Rate Work?

When you opt for a loan with a floating interest rate, the interest percentage is typically tied to a benchmark rate, such as the prime rate. The interest rate on the loan or investment will vary periodically, often about changes in the benchmark rate. This means that as the benchmark rate changes, your interest rate will adjust accordingly, resulting in fluctuations in your payment amounts or investment returns.

How to Calculate Floating Interest Rate?

To calculate a floating interest rate, you must consider the financial product and the benchmark rate. The formula for floating interest rate calculation is straightforward: 

  • Floating interest rates = Benchmark rate + Spread

The spread is an extra amount added to the benchmark rate, determining the final interest rate. For instance, if the benchmark rate is at 3%, and the spread is 2%, the floating interest rate becomes 5% (3% + 2%).

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Floating Interest Rate vs. Fixed Interest Rate

The following table provides a brief overview of the difference between floating interest rates and flexible interest rates:

Parameters

Floating Interest Rate

Fixed Interest Rate

Interest Rate

Changes over time     

Remains fixed

Predictability

Unpredictable and may change based on market conditions

Offers more predictability for borrowers or investors as they know exactly what their payments or returns will be throughout the loan tenure.

Risk

High risk

Low risk

Prepayment Penalty

Does not carry prepayment penalties

Carry prepayment penalties if the borrower pays off the loan before the end of the term.

Which Is Better, a Floating or Fixed Interest Rate?

Choosing between a floating and fixed interest rate depends on your financial situation and views on interest rates or the economy. While a floating rate might save you money, it can complicate your financial planning as it fluctuates. It potentially leads to higher expenses and carries a risk. On the other hand, a fixed rate stays constant. It allows you to plan with confidence and feel more secure, especially in cases when the interest rate rises. 

What are the Advantages of Floating Interest Rate?

A floating interest rate offers several advantages. Let's explore them below:

  • Flexibility: Floating interest rates fluctuate with market conditions, allowing borrowers to benefit from potential interest rate decreases and lower their borrowing costs.
  • Lower Initial Rates: Floating interest rates often start lower than fixed rates, providing borrowers with lower initial monthly payments and potential savings.
  • Potential Savings: If market interest rates decrease over time, borrowers with floating rates can benefit from lower overall interest costs and save money on their loans.
  • Rate Transparency: Floating rates are typically tied to an underlying benchmark, providing transparency and reflecting current market conditions.
  • Early Repayment Advantage: Floating-rate loans often allow borrowers to make prepayments without significant penalties, enabling them to save on interest and pay off their loans faster.

ALSO READ :- Flat Interest Rate Vs Reducing Balance Interest Rate: A Brief Overview

Do Credit Cards Have Floating Rates?

Yes, most credit cards come with floating, or variable rates. These rates usually change based on the prime rate. The credit card company then adds a certain percentage to set the card's interest rate. For instance, if the prime rate is 8% and the additional amount is 12%, the credit card rate becomes 20%.

What is the Process to Apply for a Loan Online? 

Follow the steps mentioned below to apply for a loan online:

  • Step 1: Press the 'Apply Now' button to access the application form.
  • Step 2: Complete the form with your details and attach the necessary documents.
  • Step 3: Click ‘Submit’, and your application will undergo processing.

To Conclude

Thus, opting for floating interest rates presents borrowers with a dynamic and often attractive alternative compared to fixed interest rates. It is crucial to thoroughly research and compare offers from different lenders to find the best interest rates that fit your financial situation. Once you have decided on the interest rate type, get a loan from Poonawalla Fincorp and fulfil all your monetary needs. 

Frequently Asked Questions About Floating Interest Rate

1.    What is the floating rate of interest?
A floating rate of interest is an interest rate that changes over time based on market conditions. For example, if you have a mortgage with a floating interest rate tied to the prime rate, as the prime rate changes, your mortgage interest rate will adjust accordingly.
2.    Are floating rate funds risky?
Floating-rate funds can be considered riskier compared to fixed-rate funds. They are more sensitive to changes in interest rates and may experience volatility in returns. However, they can also provide potential opportunities for higher returns in certain market conditions.
3.    How frequently does the floating interest rate change?
The floating interest rate is usually revised every quarter. This rate is determined by the RBI based on various economic factors. Thus, with a variation in the interest rate, the EMI for the quarter also changes.

Disclaimer

We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
*Terms and Conditions apply

poonawalla fincorp team

Poonawalla Fincorp Team

We are a team of expert writers and editors passionate about providing our readers with authentic and valuable information on finance. Our aim is to simplify financial and finance-related concepts. We strive to help our readers become more aware and empowered to make informed financial decisions.

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