Fixed vs. Variable Interest Rates: Which Is Better for Your Personal Loan?

When applying for a personal loan in India, borrowers must choose between fixed and variable interest rates. Understanding the nuances of both options can significantly affect your financial well-being over the loan's tenure. In this blog, we’ll dive into the differences between fixed and variable interest rates and help you determine which one suits your needs best.

What Is a Fixed Interest Rate?

A fixed interest rate is the interest rate on your loan that remains constant throughout the tenure of the loan. Whether you’re repaying your personal loan over one year or five years, the rate remains the same, and so do your monthly instalments (EMIs). This consistency can be appealing to borrowers who prefer stability and want to plan their finances without worrying about market fluctuations.

Know more about – What is EMI?

For example, let’s say you take a personal loan with a fixed interest rate of 12%. No matter what happens in the broader economic landscape, your loan will continue to accrue interest at 12% until the last EMI is paid. This predictability can be a huge relief, especially for risk-averse individuals who don’t want surprises.

Advantages of Fixed Interest Rates

1. Stability and Predictability: The biggest advantage of fixed rates is their certainty. You know exactly how much you will pay each month, which allows you to budget better and plan your expenses.


2. Protection from Rate Hikes: In times of economic volatility, interest rates can rise, which will increase your borrowing cost if you have a variable-rate loan. However, with a fixed-rate loan, you are safe from such fluctuations, saving you money in a rising interest rate environment.


3. Better Financial Planning: Since your payments are fixed, it becomes easier to set long-term financial goals. Whether you are saving for a vacation, a child’s education, or a down payment on a house, knowing your monthly liabilities can help you plan better.

Disadvantages of Fixed Interest Rates

1. Higher Initial Rates: Fixed-rate loans usually have higher initial interest rates than variable-rate loans. This means you might pay more at the outset than you would with a variable-rate loan.


2. Lack of Flexibility: If the Reserve Bank of India (RBI) lowers interest rates, borrowers with fixed-rate loans do not benefit from the reduced rates, unlike those with variable-rate loans, which may see their EMIs reduce.

Also read: Interest Rate on a Personal Loan in India

What Is a Variable Interest Rate?

A variable interest rate, a floating or adjustable rate, fluctuates based on market conditions. In India, variable interest rates are usually linked to the benchmark lending rates set by the RBI or the Marginal Cost of Funds-based Lending Rate (MCLR) of banks. As these rates change, so will the interest you pay on your personal loan.

For example, if you take a personal loan at an initial variable rate of 11%, this rate could decrease to 9% or increase to 13% depending on economic factors like inflation, government policies, or global financial trends.

Advantages of Variable Interest Rates

1. Lower Initial Rates: Variable-rate loans usually start with a lower interest rate than fixed-rate loans. This can be advantageous if you expect to repay your loan quickly or if you anticipate interest rates falling soon.


2. Opportunity for Savings: If market rates drop, your interest rate and EMIs will also decrease, which can result in significant savings over time. Borrowers willing to take some risk could benefit from reduced interest costs if rates trend downward.


3. More Flexibility: A variable-rate loan offers the possibility of paying less over the loan's tenure, especially if the economy experiences a period of lower interest rates.

Disadvantages of Variable Interest Rates

1. Uncertainty: The biggest downside of variable rates is the unpredictability. Interest rates can rise at any time, increasing your EMIs and making it harder to budget for future payments.
   Also Read: How to Calculate Your Personal Loan EMI Using Excel


2. Potential for Higher Costs: If interest rates rise significantly, the cost of your loan could skyrocket. For borrowers on tight budgets, this can pose financial strain, as higher EMIs may disrupt monthly cash flow and lead to difficulties in repayment.


3. Complex Financial Planning: The fluctuating nature of variable rates can make financial planning more challenging. You may not always know how much you’ll be paying in the future, which could hinder long-term goals.

Factors to Consider When Choosing Between Fixed and Variable Interest Rates

1. Risk Tolerance: Fixed rates are best for those who prefer security and do not want to deal with market uncertainties. On the other hand, if you’re comfortable with some level of risk and want to save money if rates fall, a variable rate might suit you better.


2. Loan Tenure: If you opt for a short loan tenure, a variable rate might be more beneficial because you can take advantage of any rate drops. For longer tenures, fixed-rate predictability could provide peace of mind.


3. Current Economic Conditions: If the market expects a rise in interest rates, locking in a fixed rate could be advantageous. Conversely, a variable rate could help you save money if rates are expected to fall.


4. Financial Goals: Fixed rates are better suited for those who need financial certainty, such as individuals with a fixed monthly income. Variable rates, on the other hand, may be attractive to people who are looking for potential savings and are okay with managing fluctuations in EMIs.

Conclusion: Which is Better for Your Personal Loan?

Choosing between fixed and variable interest rates largely depends on your financial situation, loan tenure, and risk appetite. If you prioritise stability, a fixed-rate personal loan will offer peace of mind with predictable payments. However, if you’re willing to take on some risk to benefit from lower rates, a variable-rate loan may be the better option.