All About Floating Interest Rate


Floating Interest Rate - Basic Definition

The rate of interest that fluctuates depending on the economic conditions is known as floating interest rate. In other words, this interest rate does not remain constant throughout the loan tenure. Floating interest rates are levied on different loans such as a home loan, personal loan, car loan, etc.

The floating interest rate can change periodically depending on an underlying benchmark or base rate. If the base rate increases, the floating rate also increases and vice versa. Due to its dynamic nature, floating interest rate is also known as variable, adjustable, and flexible.


How Floating Interest Rate Impacts EMI Repayment?

Along with the ups and downs of the market, interest rates also rise and fall. In India, most loans with floating interest rates are subject to changes in the repo rate, the RBI’s benchmark rate for lending money to financial institutions. Lenders charge an additional amount called spread over the repo rate.

This fluctuating nature may impact your EMIs. Any time there is a change in the repo rate, your EMI or loan tenure could change with the interest rate. The outstanding amount with a floating interest rate could be less or more than the fixed interest rate.

Lenders can adjust floating interest rates semi-annually, quarterly or annually. As a borrower, you have a choice to pick an interest rate between floating or fixed. You can opt for a floating interest rate if you wish to lower the applicable interest rate or are looking for a dynamic interest rate.

Key Takeaways

  • Floating interest rates change periodically with market movements. Factors like the repo rate, the economic status of a country, inflation rate, and government monetary policies tend to affect this change.
  • This dynamic nature of interest rates affects EMI repayments throughout the loan tenure.
  • Floating interest rates currently charged by lenders are comparatively lower than the prevailing fixed interest rates.

Understanding Floating Interest Rate

As the name suggests, a floating interest rate is dynamic as it changes periodically according to market movements. Your EMIs will vary throughout the loan tenure if you opt for a floating interest rate.

Lenders set the floating interest rate based on the base rate or reference rate. The reference rate is market-determined, and the fixed margin is known as the spread. This is the basis for determining how much your interest rate will jump or fall when you opt for a floating-rate loan.

Market adjustments by the Reserve Bank of India influence the reference rate (repo rate), which eventually determines the floating interest rate. Neither your credit profile nor the lender's discretion decides this reference rate.

Types of Products With a Floating Interest Rate

Usually, home loans and other mortgage loans carry floating interest rates. Credit card companies might also offer floating interest rates to borrowers. In such cases, the bank charges floating interest rates are usually the sum of the prime/base rate and fixed margin/spread.

Advantages and Disadvantages of Floating Interest Rates

Advantages

  • With low-interest rates, floating rates could contribute towards better savings.
  • Lower interest rates also attract borrowers opting for long-term loans.
  • Unlike fixed interest rates, no prepayment charges are applicable for EMI repayments with floating interest rates.

Disadvantages

  • Fluctuations of floating interest rates are unpredictable and are beyond the control of lending institutions.
  • As these interest rates change every month, it is hard to calculate the total obligation. This can also make it challenging to compare how much of a loan is fit for your need(s).

Final words

Floating interest rates change frequently with market fluctuations, which makes the monthly repayments fluctuate or "float". Factors like inflation rate, repo rate, global interests, fiscal deficit and government monetary policy decide the floating rate charged by lenders. However, loans with a longer tenure may be more cost-effective than fixed-interest rate loans.

Other Words

  • Fixed Interest Rates
  • Flexi Loan

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