Fixed Rate or Floating Rate for Loans
Today, getting a loan is easy and effortless but the predicament which one has to go through is while choosing over Fixed Rate or Floating Rate interest, it’s a dilemma which one would not like to go through.
While completing my MBA, in a finance lecture, I remember the faculty making a statement on loans; of course he had gigantic experience and a PhD. in management to support it. He asked us to “Get a home loan at a Fixed Rate as the rate is likely to fluctuate in the following months” and emphasized on the fixed rate being a better alternative over floating rate. Around a week passed by and my brother got approved for a home loan, back then, I made the same point to my brother and to the sales executive from the respective financial institution and the response which we got from the sales executive made us choose Floating Rate over Fixed Rate. He avowed that “Floating Rate will at all times be lower than Fixed Rate and that’s how we do business.”
That statement exterminated the false belief I had on the term “Fixed Rate”, till the moment, “Fixed Rate was a Rate which remains unchanged for the tenure of the loan” but it really doesn’t work out that way with the loans in a stretched tenure. Reading the fine prints gave a different view altogether, A fixed rate will remain fixed for a given period, say 2-5 years, after that the bank will adjust the rate to match up with Public Lending Right and other factors such as market and competition. The greater the years, the higher will be the rate on a Fixed Rate structure.
The decision to choose between rates depends on risk factor. Those who suspect high fluctuation in near future should take Fixed Rate and for others a floating rate attached to banks fixed deposit rate - which provides more transparency in rate allocation and will be superlative. However one should be aware that one can switch between the rates later correcting the difference between the both. The decision to do so should be with consideration to the interest rate benefits and fees.
Drawbacks
- Fixed Rates attract higher premium compared to floating.
- Floating Rates fluctuate with market conditions and are not ultra transparent.
The consideration to swap between the two should be examined quarterly or bi-quarterly keeping in the mind the benefits and benefits forgiven.