Fixed vs Floating Interest Rate – Which i Better for Your Loan?

With the increasing demands and inflation we are moving towards financing our needs and necessities on EMIs (you can calculate your EMI using our EMI Calculator instead of buying by paying all the money at once. But it is crucial to understand how the interest rate on loans works. As there could be fixed or floating interest rates on EMIs, which are completely different things. If you don’t know about these EMIs, it could get you in trouble.

In this article, I am going to explain all about the fixed vs floating interest rate, how the interest rate affects EMI, floating rate EMI changes, and the RBI repo rate EMI impact, which will certainly help you to understand how they work, and you might be able to avoid various troubles. 

What Is Interest Rate in Loans

Interest rate is the cost of borrowing money from a bank or any other financial institution. It is charged on the outstanding principal amount borrowed and expressed as a percentage per year. In simple terms, interest will cost you an extra ₹90,000 in one year when you borrow 10lakhs at an interest rate of 9 per annum (without considering the structure of repayment).

Banks charge interest because they are giving out money, which could be invested in other areas and bring returns. Most retail loans in India are computed using compound interest on a monthly basis. Interest rates are affected by the Reserve Bank of India (RBI) policy, inflation, economic growth and the own cost of funds used by the bank. You can also learn how banks calculate EMIs step-by-step using tools like Excel-based EMI calculations for better clarity The rate that you get is also dependent on your credit score. Ultimately, the interest rate charged on you will be determined by your credit rating, loan balance and term. It works on the high-risk, high-return principle.

What is Floating Interest Rate

If the rate of interest is not fixed and has room for changes, it is called a floating interest rate. It means that changes in the economic factors, inflation, or policy decisions from central banks can have a significant impact on the rate of interest, as well as your EMIs. Take a similar scenario as before, but this time you bought a car with a floating rate of interest, and the prices drop. Now, the lender is bound to lower the interest on your car according ot floating interest rate policies. It means you can save money by opting for a floating interest rate if prices drop or vice versa.

Floating rate meaning

A floating interest rate, otherwise called a variable or adjustable rate, changes in the middle of the term of the loan. It changes depending on the market conditions. It is determined by the banks to a standard rate, which is normally the RBI Repo Rate and a pre-established premium (margin). Understanding how EMIs change under different structures is easier when you compare monthly vs daily reducing balance methods

An example of this is the home loan rate, which is Repo Rate plus 2.50%. When the RBI Repo Rate is 6.50%, then your effective rate is 9.00%. When the RBI alters the repo rate, your bank will reprice your interest rate after a specified number of years (which it is known as the reset period). When the rates are low, you are lucky, and when they are high, you will pay more in EMIs.

What Is Fixed Interest Rate

It is the rate of interest that remains fixed once you borrow the item. Change in prices and the economy doesn’t have any impact on the fixed interest rate. For example, you purchase a car on 12% interest rate (fixed), but with an increasing market, the car price hikes; even in this situation, the lender would be bound to the same rate of interest and cannot amend the terms of interest. Use our car loan EMI calculator to simulate this scenario.

You should choose between fixed and floating interest rates, depending on the extent of risk you are ready to bear and the market conditions. Floating rates can help you to save money in case you believe that the rates will decrease; however, they are accompanied by the possibility of the rates increasing.

Fixed vs Floating Interest Rate

Here is a clear side-by-side comparison:

Feature	Fixed Interest Rate	Floating Interest Rate
Rate movement	Remains constant throughout the tenure	Changes with market benchmarks (Repo Rate)
EMI behaviour	Fixed every month	Changes at every reset period
Initial interest rate	Usually 0.25–0.50% higher	Usually lower
Risk level	Low (predictable)	High (uncertain)
Benefit when rates fall	None	You save on interest and EMI
Benefit when rates rise	Protected	EMI or tenure increases
Best suited for	Risk-averse borrowers, long tenure	Borrowers who expect rates to fall
Prepayment charges	Usually applicable	Usually not applicable after certain period

How Interest Rate Affects EMI

The two elements of the EMI are principal repayment and interest. The EMI is also adjusted according to fluctuations in the rate of interest.

• EMI increase: A higher proportion of your EMI is charged to interest in case of an increase in the interest rate, which is characteristic of floating loans. In an attempt to retain the same loan term, the bank increases the EMI amount. As an example, the rise in interest rate by 1% on a loan of ₹30 lakh may lead to a rise in EMI by ₹1,500-₹2,000.
• EMI decrease: When the interest rate is low, a greater percentage of EMI is charged on the principal. The bank has the option of reducing the EMI with the same tenure or reducing the tenure with the same EMI (you pay earlier).

Why Floating Rate EMI Changes

The main thing to know about borrowing is that the EMI rates may change. The floating rates in comparison to the fixed rates are bound to such benchmarks as the Marginal Cost of Funds-based Lending Rate (MCLR) or External Benchmark Lending Rate (EBLR), which may vary every three months or even less frequently.

In case of an increase in interest rates, the lenders tend to increase your EMI to cover the increased cost. They might also extend the loan period in order to maintain the same EMI (as per the regulation). Reduction of rates, on the other hand, implies reduced EMIs or reduced loan terms. The floating rates EMI adjustments would be good in downward trend rates but bad in upward rates. Borrowers must be keen on such changes as they impact cash flow and long-term savings.

Interest Rest Period

Floating rate loans do not vary on a daily basis. The banks are usually reset after every three months (quarterly) or after 6 months. The bank will charge its own fixed spread and check the existing benchmark rate (Repo Rate) on the reset date. To the next reset period, the new rate is applicable.

This is the reason why your EMI can remain constant for three to six months and suddenly shift. Some banks also allow you to change the floating into fixed or the other way round at a small fee.

RBI Repo Rate and Its Impact on EMI

RBI Repo Rate EMI Impact

The RBI Repo Rate is the interest rate that the Reserve Bank of India charges commercial banks when they borrow money for a short period of time. It is the most essential part of the RBI’s monetary policy.

• When inflation is strong, the RBI raises the Repo Rate, which makes banks charge more for loans, and floating loan EMIs go up.
• When the economy needs a boost, the RBI lowers the Repo Rate, which lowers the interest rates on loans and floating loan EMIs. 

Monetary Policy

The monetary policy instruments used by the Reserve Bank of India (RBI) have a lot in determining the setting of the interest rates, particularly the repo rate, which is the interest rate at which the banks borrow funds from the Reserve Bank of India. The RBI repo rate EMI is the one that influences the floating rate loans the most, because banks will transfer any alteration in the repo rate towards the consumers.

As an example, when the RBI increases its repo rate to combat inflation, the banks also increase their lending rates, and consequently, the EMIs to people with floating rate loans are also increased. Under the economic recovery after 2020, the repo rate increased by 4% to approximately 6.5%, which led to an increase in the EMIs of many house loan holders by 20% to 30%. Conversely, repo rates are reduced, such as those experienced during recessions and this cuts EMIs, which is desirable. Knowing the impact of the RBI repo rate on the EMIs will assist the borrowers in preparing in accordance with the changes and may shift to fixed rates in case of an increase in rates.

To compare the effects, we have a table of a hypothetical 15-year ₹30 lakh home loan in ₹30 lakh in India that looks like this:

Interest Rate Type	Initial Rate	EMI at Start	EMI After 2% Rate Hike	Total Interest Paid (Approx.)
Fixed	8.5%	₹29,529	₹29,529 (unchanged)	₹23,15,220
Floating	8.0%	₹28,660	₹31,000 (adjusted)	Variable (depends on hikes)

Fixed vs Floating Interest Rate – Pros and Cons

When you choose between fixed and floating rates, you have to think about how stable they are and how much money you could save. Before deciding, it’s important to plan your repayments properly using smart EMI budgeting strategies. Here’s a list:

Fixed Interest Rates:

• Pros:
  • You can easily plan your budget because the EMIs are always the same.
  • Protects against rising interest rates.
  • It is also best for borrowers who don’t want to take risks.
• Cons:
  • Fixed rates are usually higher starting rates than floating rates.
  • Lowering prices will not save you any money.
  • There may be fees for paying early.

Floating Interest Rates:

• Pros:
  • Lower starting rates, which means lower EMIs at first.
  • If market rates go down, you can save money.
  • You have the option to swap or renegotiate.
• Cons:
  • You could have to deal with variations in floating rate EMI.
  • The RBI repo rate EMI impact could make things more expensive.
  • Needs to keep an eye on economic data all the time.

Which Is Better: Fixed or Floating Interest Rate

Among the floating and fixed interest rates, which one is better? It is the most common question among consumers while making a decision. But in reality, there is no one answer to this question, as it depends on the borrower’s situation. You should opt for a fixed interest rate if you don’t like uncertainty, or if you are completely sure that the market of a certain product will not crash. It is also recommended to choose a long-term loan at a fixed rate, as you may face many negative uncertainties in the long run. Moreover,  people who can’t afford any increase in EMI should never opt for this.

On the other hand, a floating interest rate is a kind of gamble. Let’s say you are a person who can afford a 15-20% increase in EMI, which can put risk into it. Looking at market conditions, there could be a case when interest rates may fall. OR when you plan to repay the loan early, so in the short run, there might be fewer uncertainties. However, strategically, you can choose a floating rate to enjoy a lower rate for some time, and then shift to a fixed interest rate if you see a rise in interest rates. Banks may allow this switch 1-2 times during the loan tenure.
If you plan to switch or repay early, you should also understand loan foreclosure rules and charges.

How EMI Is Calculated

Banks use the reducing balance method. The standard formula is:

For example, consider a loan of ₹50 lakhs with an 8% interest rate for 20 years. Using a common EMI formula:

EMI=Pr(1+r)n(1+r)n-1

• P is the principal 
• r is the monthly interest rate 
• n is the number of months 

The EMI might be roughly ₹41,822 at 8%. At 9% rate, EMI will increase to approximately ₹44,986, which is ₹3,000 higher every month. This demonstrates how small rate hikes can make it difficult. It also shows the need to consider potential changes when choosing your type of loan.

Conclusion

In order to handle your EMI, you should be aware of how to handle fixed and variable interest rates. To select the suitable loan that meets your financial requirements, compare EMIs using an online EMI calculator before finalizing your loan. Consider the degree of risk that you are ready to take and the market conditions, and see whether it is more worthwhile to concentrate on stability or searching the ways to save money. Never decide on loans without consulting lenders or other financial experts in order to ensure that your loans contribute to your financial well-being rather than being a liability.