As the name suggests, Fixed Interest Rate allows the repayment in fixed equal monthly installments over the entire period of the loan. The interest rates in such a case are fixed and don’t change with market fluctuations. During the early part of loan tenure the majority of monthly payments are used to service the interest and principal is served in the later parts of loan tenure. Thus the borrower knows the exact amount he needs to pay in the future or at least he knows the exact interest rate to pay for the outstanding loan at that time. For example, if a person borrows money at fixed interest rate of 12% per annum for five years, then he/she would need to pay an interest of 12% on the outstanding principal every year.
On the other hand, Floating Interest Rate which is also referred to as Variable or Adjustable Interest Rate is any debt instrument that does not have a fixed interest rate. The time period for a Car Loan plays an important role in deciding this fixed percentage. The borrower decides the time period and the lender charges the interest rate accordingly. This period generally ranges from 1 month- 7 years.
Advantages of Fixed Interest Rate:
- It gives a sense of certainty to the borrower and the lender. It is free from risk and allows the lender to get regular repayments.
- It is easy to keep a track of your cash flows and both the parties have complete and accurate information about the loan. Chances of quarrels on the perspective of fraudulent practices are reduced.
Disadvantages of Fixed Interest Rate:
- Fixed Interest Rates are usually higher than the floating interest rate as they based on an expected value of the future changes in interest rates. So, the banks always keep a cushion to aid in times of any heavy fluctuations.
- If for any reason the actual rate decreases, the borrower still has to pay a higher rate. Though this is profitable for the lender, as he gets a higher rate and earns more.
Advantages of Floating Interest Rate:
- Floating Interest Rate is around 1-3% lower than the Fixed Interest Rate. This percentage means a lot. Even if the rate rises above the fixed rate it is bound to get reduced by the time you pay your next installment.
- It provides you with an option to earn well, as per the market conditions; you can give out a loan at fixed interest rate and pay your own loan at a floating rate.
Disadvantages of Floating Interest Rate:
- It is difficult to keep account of the cash flows for both the lender and the borrower. None of the parties has complete information about the loan amount, as the rates keep on fluctuating at a very fast speed.
- At times, there have been a large number of instances in the past, where the borrowers had to shell out huge bucks, as the interest rates sky-rocketed due to changes in the international market rates. So, the risk element increases. You may have to lose it all.
As per my recommendation, as a Commerce Student, it is profitable to go for a fixed interest rate loan for your car. Car is one-time investment. You do not buy cars every day. So, it is acceptable to buy a car that actually costs beyond your pocket. This is the reason for the existence of various financial institutions and banks. So, it is better to buy a car and then keep on paying the fixed rate every month. Sometimes, to save that 1-2%, you may have to shell out a 5% more. It is also difficult to keep a track of the changing interest rate.
For Car Loan, it is better to take a Fixed Interest Rate Loan from the State Bank of India or one of its regional branches. Such banks provide the additional benefit of being a public bank, whose main aim is the welfare of the society and not profit-making. So, these banks are reliable and carry the Brand Name. Though the documentation might be a task sometimes, but it does not happen always.
So, go ahead! Get the best car at cheaper rates or in other words, Fixed Interest Rates. All the Best! Happy Saving! My friend’s father did the same and he is very happy with it. So, learn from others’ experience.