Question

In which cases are fixed rates better than floating rates? In which cases are floating rates better than fixed rates?

Answer 1

Fixed interest rate is one where the rate of interest remains fixed throughout the tenure of the loan. The fixed interest rate is more or less 1% or 2% higher than the floating interest rate.

The floating interest rate is one which changes with market conditions. The rate of interest changes with the changes in the base rate.

A fixed interest rate is best suited in the following circumstances.

1. The fixed interest rate is best when the income of the borrower is fixed. But to opt for floating interest rate is not suited for a person whose income is fixed.

2. Under the fixed interest rate the tenure and EMI are fixed, the borrower can plan his repayment most accurately with his fixed income. But such preplanning is not possible under the floating interest rate.

3. Fixed interest rate is better with regards to market risk. The borrower does not face any uncertainty from the fluctuations in the market rate. But the borrower faces market risk of uncertainty under floating interest rate.

A floating interest rate can be recommended in the following grounds.

1. The floating interest rate allows the borrower to make repayment with the excess income and enables him to pay off the loan faster and reduce the total interest payable on the loan. Thus a floating interest rate is best suited for a person who expects a rise in income. But under the fixed interest rate the borrower cannot reduce his financial burden by paying excess amount.

2. The rate of interest is low in case of floating interest rate. Thus the cost of borrowing is low under the floating interest rate. But the cost of borrowing is high under the fixed interest rate.

3. The borrower benefit from the advantage from the fluctuations in market rate. If the market rate falls below the base rate, the interest rate will be lower than the base rate. This gives extra gain to the borrower. Such an unanticipated gain is not available to a borrower who opts for fixed interest.