Choosing between fixed and floating rates? Here’s what most people get wrong

One of the key decisions when borrowing is whether to opt for a fixed or a floating interest rate.

For those who are not aware, let us first understand the key differences between the two. Loans linked to a fixed rate of interest are those in which the loan EMI remains the same throughout the loan tenure. 

In floating interest rate loans, the interest rate fluctuates with a benchmark, e.g., the repo rate. As a result, your EMI keeps changing – upward or downward – along with interest rates.

These are some of the factors which can influence your choice.

Fixed vs Floating: What to choose?

I. Tenure of loan: Generally, short-term loans are better off when interest rates are fixed. On the other hand, long-term loans, such as home loans, typically have floating interest rates.

II. Risk appetite: Those who want predictable loan EMIs prefer to choose a fixed rate of interest, whereas those with a slightly higher risk appetite may go for a floating rate of interest on their loans, especially when they anticipate lower interest rates in the near future.

III. Interest rate cycle: Another criterion of choosing one over the other is the current interest rate cycle. When interest rates are on a decline, it is recommended to opt for floating interest rates. Conversely, when interest rates are set to increase in the near future, you could choose fixed interest rates so that you could lock them during the loan's tenure beforehand.

IV. Stable income: Another criterion for choosing between fixed and floating interest rates is the stability of your income. If your income is stable, i.e., you receive a fixed salary, you are more likely to go for a fixed EMI, unlike in self-employment or a business, where it is easy to handle fluctuating EMI.

V. Long tenure with fixed EMIs: It is also important to mention here that one can keep their loan EMI fixed even after choosing a floating rate of interest.

This is done by changing the loan tenure – shorter or longer – after a decrease or increase in interest rates, respectively.

Nevertheless, switching from a fixed to a floating interest rate, and vice versa, is subject to additional charges. RBI rules allow banks to charge a levy when customers switch loans from one category to another.

“(Banks)… can levy applicable charges for switching of loans from floating to fixed rate or vice versa and or any other administrative costs incidental to the exercise of the switchover options,” reads an RBI statement as on 10 Jan 2025.

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