A personal loan is an unsecured loan with interest rates usually ranging between 10.5% to 24% per annum depending on the credit score and bank policies. While approving a loan, banks present two main options to the customers – Fixed Interest Rate and Floating Interest Rate.
Choosing the right option not only impacts your monthly EMI but can also make a difference of thousands of rupees in the total interest paid over the entire loan tenure.
Fixed Interest Rate: In this, the interest rate remains completely stable during the loan tenure (say 3 to 5 years). Even if the repo rate is increased or decreased by the Reserve Bank of India (RBI) in the market, there is no impact on your monthly EMI or loan tenure.
Floating Interest Rate (Variable Interest Rate): This rate is linked to the bank’s external benchmark lending rate (EBLR/Repo Rate). When RBI cuts policy rates, your interest rate and EMI decreases; At the same time, as rates increase, the interest burden increases.
| scale | Fixed Interest Rate | Floating Interest Rate |
| initial interest rate | Usually 1% to 2.5% more than floating | Relatively cheap in the beginning |
| Estimated EMIs | 100% assured, equal installment every month | May fluctuate with market rates |
| Benefits of Interest Rate Cycle | There is no financial benefit from falling interest rates | Direct benefit from rate cut by RBI |
| Pre-payment/foreclosure penalty | Banks may charge pre-payment charges ranging from 2% to 4% | Zero (0%) penalty on floating rates as per RBI rules |
| Who should choose? | For those who prefer a fixed monthly budget and low risk | In an era of falling interest rates and for those with pre-payment plans |
Suppose you are taking a personal loan of ₹ 5,00,000 for 5 years (60 months). Available in the market at fixed rate 13.5% and floating rate 11.5%:
$$\text{Monthly EMI} = P \times r \times \frac{(1+r)^n}{(1+r)^n – 1}$$
| Description | Fixed Rate (13.5% fixed) | Floating Rate Scenario A (11.5% remains constant) | Floating rate scenario B (average remains at 12.0%) |
| Loan Amount (Principal) | ₹5,00,000 | ₹5,00,000 | ₹5,00,000 |
| Monthly EMI | ₹11,504 | ₹10,996 | ₹11,122 |
| Total Interest Payable | ₹1,90,240 | ₹1,59,773 | ₹1,67,333 |
| Total Payment (Principal + Interest) | ₹6,90,240 | ₹6,59,773 | ₹6,67,333 |
By choosing floating rate you can earn approx. in 5 years. Direct savings of ₹23,000 to ₹30,000 Can be done, provided there is no unexpected huge jump in interest rates during this period.
It is essential to understand one hidden rule while taking a personal loan:
RBI Guidelines on Floating Rate Loan: As per the guidelines of the Reserve Bank of India, no bank or NBFC can impose any penalty for foreclosure or part-payment on personal loans taken at floating rate.
Lock-in and charge at fixed rates: In fixed rate loans, banks often have a lock-in of 6 to 12 months and charge a penalty of 2% to 4% on the outstanding balance for premature closure of the loan. If you expect to repay the loan with the bonus or savings in the next 1-2 years, choosing a floating rate is the safest and most economical move.
