Be it a home or business loan, banks and non-banking financial institutions either charge a fixed or a floating interest rate to the borrower. Apart from the interest rate (in percentage) charged on the business loan, you, as the consumer, should also be wary of the type of interest rate that is levied on the loan. This can directly impact your ability to service and settle your loan in due time.
What is a fixed interest rate and how does it differ from a floating interest rate? Let us understand their differences in the following sections.
In simple terms, a fixed interest rate means that a loan borrower pays the same interest through the entire tenure of the loan. Specifically, loans with a fixed interest rate come with a fixed EMI (or monthly payment) for the borrower.
How does a fixed interest rate benefit you as a business loan borrower?
It provides a sense of security as you know the EMI amount that you need to pay every month and for the entire loan tenure.
Your loan payment is not affected by any market fluctuation or changes in interest rate.
Lesser short-term risk particularly for short-to-medium term loans of three to five years.
Ideal for borrowers who have a fixed budget for servicing loan repayments each month.
A floating interest rate means that a borrower pays the currently applicable interest rates on the loan. That is, loans with a floating interest rate come with an EMI (or monthly payment) that can keep changing through the loan tenure. For instance, when the base interest rate offered by the lender goes up, the business loan interest rate goes up—and the other way round.
How does a floating interest rate benefit you as a business loan borrower?
A lower interest rate can help you save money on your EMI payments.
A reduced floating rate can even reduce the tenure of your business loan.
For new loans, most banks and financial institutions charge a lower floating rate as compared to the fixed rate, thus enabling you to save more money.
Lesser risk on long-term loans (over 10 years) as interest rates in the market are unlikely to remain high over the entire duration.
What are the primary differences between these two types of interest rates? Let us compare them under each of the following categories:
The main difference between floating rate and fixed interest rate is that a floating interest rate is always lower as compared to fixed rates for any loan amount. Typically, if the fixed interest rate is around 10%, then the floating rate would be lesser by approximately 2%–2.5% at 7.5%.
This means that you end up saving more money, even if the floating rate were to increase by a few percentage points.
For a fixed interest loan, the monthly EMIs are always constant in addition to the loan tenure. With fixed interest loans, you are aware of the payments you need to make in advance–and for how long you need to pay them.
With a floating interest loan, your EMI amount changes whenever there is any revision in the interest rate. Depending on the revision, you could be paying a higher (or lower) EMI. Some lending institutions may keep your EMI constant, but choose to modify the loan tenure.
The market factor or conditions do play a critical factor in choosing between a fixed or floating interest rate. When the prevailing interest rates are stable (or are expected to increase in the future), it is better to opt for a fixed interest rate.
Conversely, when the prevailing interest rates are high and are expected to reduce in the future, it is advisable to go for a loan with a floating interest rate.
Depending on the lending bank or institution, full (or partial) prepayment of fixed interest loans could attract a penalty, especially for short-term business loans. Prepayment charges (or percentages) can vary among lenders.
Contrastingly, floating interest loans attract zero (or minimal) prepayment penalties.
Which of these two types of interest rates is better for you? Here are some deciding factors:
Fixed interest rates are ideal for borrowers in the higher age bracket (over 45 or 50 years) looking for short-term business loans. On the other hand, floating interest rates are preferred by younger borrowers (in their 20s) looking to repay their loans over a longer tenure.
Floating interest loans are easier to prepay, making them ideal for borrowers who are expecting to accumulate extra income (towards loan settlement). If you are expecting an increase in your monthly income in the future, floating interest loans are a better alternative.
Fixed-interest loans are better suited for borrowers who have a fixed income and are not expecting any major change. Fixed interests are also suited for strict budget planners who do not want to risk any major revisions in their EMIs.
Here are 10 reasons why you must go for a business loan with Shriram Finance:
This financial company has over 45 years of experience operating in the Indian market.
Offers a competitive interest rate on MSME loans making it ideal for small- to medium-sized businesses.
Fast and easy disbursement of loans ranging from 1 lakh to over 100 lakh rupees.
Competitive interest rates starting from 15% that are customized according to the loan borrower’s profile.
Flexible loan tenure ranging from 12 to 60 months, along with interim loan facility (for additional funds).
The convenience of opening an offline (or walk-in) or online fixed deposit—for both cumulative and non-cumulative deposits.
Eligibility for small-to-medium business owners running a business for at least 3 years and with a business turnover of over 20 lakh rupees.
Less than 2% fee in loan processing, along with easy loan repayment through EMI facility.
Minimum supporting documentation in the form of one identity proof, one address proof, passport-size photographs, and income proofs.
Loan foreclosure charges of 3%–6% levied on the outstanding loan principal and remaining tenure.
As outlined in this article, both fixed and floating interest rates have their share of pros and cons. As the business loan borrower, you need to make your choice depending on your loan requirements and comfort levels in paying back the loan.
As an established financial institution, Shriram Finance offers low-interest business loans at the best market rates. Are you looking for the right loan to grow your business? Apply for an instant business loan with your contact details on our website today.