Are you planning to take out a loan to buy a two-wheeler? Financing the bike through a loan involves a critical decision: opting for a fixed or floating interest rate loan. The interest rate you pay significantly impacts your financial planning and loan affordability, so it's crucial to thoroughly understand the differences between fixed and floating rates before choosing one.
This blog breaks down the key difference between a bike loan's floating and fixed interest rates to help you make an informed decision.
What is a Fixed Interest Rate?
As the name suggests, a fixed rate remains constant throughout the loan tenure. It does not change with market conditions.
For instance, if you take a 5-year bike loan at a 10% fixed rate, you will pay 10% interest every year for 5 years. Your EMI and interest outgo remain the same.
Let’s see the calculation for this with an example:
| Year | Opening Principal | Interest Rate | Interest Paid | Principal Repaid | Closing Principal |
| 1 | ₹2,00,000 | 10% | ₹20,000 | ₹23,870 | ₹176,130 |
| 2 | ₹176,130 | 10% | ₹17,613 | ₹26,264 | ₹149,866 |
| 3 | ₹149,866 | 10% | ₹14,987 | ₹28,889 | ₹120,977 |
| 4 | ₹120,977 | 10% | ₹12,098 | ₹31,778 | ₹89,199 |
| 5 | ₹89,199 | 10% | ₹8,920 | ₹34,957 | ₹54,242 |
| Total | ₹63,220 | ₹2,00,000 |
The key benefits of fixed-rate loans are:
- Predictability: You know your exact EMI and interest payouts upfront for the entire loan tenure, which helps you plan your finances better.
- Protection against rate hikes: Your EMI and interest outgo remain unchanged even if market rates rise later. You enjoy peace of mind.
However, fixed rates also come with a drawback:
- You cannot benefit if interest rates fall later. Your EMI and payouts remain fixed at the higher pre-set rate.
Overall, fixed interest rates offer stability and are ideal for people prioritizing predictability over potential savings from rate cuts.
What is a Floating Interest Rate?
In floating-rate loans, the interest rate varies based on an external benchmark such as the RBI's repo rate.
Every time the benchmark rate changes, your interest rate also changes. As a result, your EMI and total interest payout fluctuate over the loan tenure.
Let’s see the calculation for this with an example:
| Year | Opening Principal | Interest Rate | Interest Paid | Principal Repaid | Closing Principal |
| 1 | ₹200,000 | 10% | ₹20,000 | ₹23,870 | ₹176,130 |
| 2 | ₹176,130 | 11% | ₹19,374 | ₹24,492 | ₹151,638 |
| 3 | ₹151,638 | 12% | ₹18,197 | ₹25,679 | ₹125,959 |
| 4 | ₹125,959 | 11.5% | ₹14,435 | ₹29,441 | ₹96,518 |
| 5 | ₹96,518 | 10.5% | ₹10,134 | ₹33,742 | ₹62,776 |
| Total | ₹72,136 | ₹200,000 |
The pros of floating rates are:
- Potential savings: You can gain when interest rates fall as your payouts decline.
- Lower initial rates: Floating rates are often lower than fixed rates initially, reducing the initial burden.
However, floating interest rates also have some disadvantages:
- Unpredictability: Your outgo fluctuates, making financial planning difficult.
- Vulnerability to hikes: Rates and payouts can rise significantly if market rates increase later.
To summaries, floating rates offer the flexibility to avail of rate cuts but expose you to rate rise risks. They are more suitable for people comfortable with fluctuation and uncertainty.
Key Differences Between Fixed and Floating Rates
Now that we have understood both interest rate types, let's look at a quick side-by-side comparison:
| Parameter | Fixed Rate | Floating Rate |
| Fluctuation in rates | No fluctuation for the entire tenure | Changes based on market conditions |
| EMI amount | Fixed EMI for the entire tenure | Varies over the loan period |
| Protection from hikes | Full protection | Vulnerable to rate hikes |
| Ideal for | Disciplined users, Predictability-focused | Market-savvy customers, Risk-taking ability |
This table summarizes the key contrasts between the two interest rate types concerning fluctuation, predictability and ideal customer profiles. Evaluate your needs and priorities to choose the suitable option.
Conclusion
Choosing between a fixed or floating interest rate for your bike loan is an important decision that requires careful evaluation of your financial situation and risk tolerance. Fixed rates provide stability and predictability while floating rates offer flexibility to gain from rate cuts. Analyse your priorities, loan tenure, income stability, and interest rate outlook before deciding the ideal option.
