A personal loan is an unsecured loan with interest rates usually ranging between 10.5% to 24% per annum depending on the credit score and bank policies. While approving a loan, banks present two main options to the customers – Fixed Interest Rate and Floating Interest Rate.
Choosing the right option not only impacts your monthly EMI but can also make a difference of thousands of rupees in the total interest paid over the entire loan tenure.
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Fixed Interest Rate: In this, the interest rate remains completely stable during the loan tenure (say 3 to 5 years). Even if the repo rate is increased or decreased by the Reserve Bank of India (RBI) in the market, there is no impact on your monthly EMI or loan tenure.
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Floating Interest Rate (Variable Interest Rate): This rate is linked to the bank’s external benchmark lending rate (EBLR/Repo Rate). When RBI cuts policy rates, your interest rate and EMI decreases; At the same time, as rates increase, the interest burden increases.
| scale | Fixed Interest Rate | Floating Interest Rate |
| initial interest rate | Usually 1% to 2.5% more than floating | Relatively cheap in the beginning |
| Estimated EMIs | 100% assured, equal installment every month | May fluctuate with market rates |
| Benefits of Interest Rate Cycle | There is no financial benefit from falling interest rates | Direct benefit from rate cut by RBI |
| Pre-payment/foreclosure penalty | Banks may charge pre-payment charges ranging from 2% to 4% | Zero (0%) penalty on floating rates as per RBI rules |
| Who should choose? | For those who prefer a fixed monthly budget and low risk | In an era of falling interest rates and for those with pre-payment plans |
Suppose you are taking a personal loan of ₹ 5,00,000 for 5 years (60 months). Available in the market at fixed rate 13.5% and floating rate 11.5%:
$$\text{Monthly EMI} = P \times r \times \frac{(1+r)^n}{(1+r)^n – 1}$$
| Description | Fixed Rate (13.5% fixed) | Floating Rate Scenario A (11.5% remains constant) | Floating rate scenario B (average remains at 12.0%) |
| Loan Amount (Principal) | ₹5,00,000 | ₹5,00,000 | ₹5,00,000 |
| Monthly EMI | ₹11,504 | ₹10,996 | ₹11,122 |
| Total Interest Payable | ₹1,90,240 | ₹1,59,773 | ₹1,67,333 |
| Total Payment (Principal + Interest) | ₹6,90,240 | ₹6,59,773 | ₹6,67,333 |
By choosing floating rate you can earn approx. in 5 years. Direct savings of ₹23,000 to ₹30,000 Can be done, provided there is no unexpected huge jump in interest rates during this period.
It is essential to understand one hidden rule while taking a personal loan:
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RBI Guidelines on Floating Rate Loan: As per the guidelines of the Reserve Bank of India, no bank or NBFC can impose any penalty for foreclosure or part-payment on personal loans taken at floating rate.
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Lock-in and charge at fixed rates: In fixed rate loans, banks often have a lock-in of 6 to 12 months and charge a penalty of 2% to 4% on the outstanding balance for premature closure of the loan. If you expect to repay the loan with the bonus or savings in the next 1-2 years, choosing a floating rate is the safest and most economical move.