The State Bank of India (SBI) has become the latest bank to increase the marginal cost of funds-based lending rate (MCLR) on Wednesday following the Reserve Bank of India's (RBI) recent repo rate hike by 0.25 per cent, making various consumer loans dearer for borrowers.
Several banks, such as Bank of Baroda, Bank of India, and Punjab National Bank, have already increased their repo-linked lending rate (RLLR) after RBI's rate revision on February 8, 2023.
RLLR hike impacts the floating interest rates on consumer loans, affecting people as it increases the equated monthly installments (EMIs) they pay for various loans.
SBI increased the overnight MCLR to 7.95 per cent. For the one-year, two-year, and three-year duration, the rates were revised to 8.50 per cent, 8.60 per cent, and 8.70 per cent, respectively.
On the one hand, the changing nature of floating interest rate loans and on the other, the significantly high fixed interest rate loans often leave borrowers in a dilemma over what to choose.
For instance, the Axis Bank's fixed interest rate on home loans for salaried individuals is 14 per cent annually, much higher than the floating rate of 8.75 to 9.15 per cent per annum.
However, no one can be sure of the floating rates increasing further as RBI hasn't changed its course on monetary tightening, and possibly the repo rate hikes may continue to curb the current inflation.
This has left borrowers in a tight spot on whether they should go for fixed or floating rates. Here we compare and discuss the advantages and disadvantages of both scenarios.
Floating & Fixed Interest Rate
Floating interest rates can decrease or increase based on market fluctuations and repo rate hikes. In contrast, fixed interest rates are locked in on a specified interest rate for a particular period.
However, even in a fixed-rate loan, financial institutions could change the rates during the loan tenure. Executive vice president (Retd.) of Federal Bank K.A. Babu, who oversaw housing finance, says: "Borrowers may opt for a fixed interest rate if floating interest rates are likely to rise frequently. But they should consider a fixed interest program with a fixed interest reset clause longer than three years or without a reset clause. Generally, banks reset their fixed interest rates every two to three years and include a clause in the loan agreements to that effect."
He adds, "A floating rate is usually lower than a fixed rate. A borrower who decides to lock in an interest rate should carefully consider the reset clause before making a decision."
He further explains that the floating interest rates of EMIs could increase with every repo rate hike. Suppose the floating rate is 9.25 per cent and the fixed rate is 9.5 per cent, and RBI increases the repo rate by 25 basis points for two quarters, the floating rate will be 9.75 percent, higher than the fixed rate at the end of two quarters. But, it should be noted that the borrower has been paying a fixed rate of 9.5 percent for several years now when the floating rate was only 9.25 per cent.
Says Atul Monga, founder, and CEO of Basic Home Loan: "The market volatility has necessitated a change even for fixed interest rate loans, with borrowers now needing to weigh up their options carefully. Fixed interest rate is ideal for borrowers who are conscious of budgeting, as it requires fixed, equal installments throughout their loan tenure."
"The fixed interest rate is usually 1-2 points higher than the floating interest rate, and borrowers do not benefit from the lowered interest rate if the market fluctuates in the latter's favour. On the other hand, a floating interest rate is affected by market conditions, with the lender adding a floating element to the loan beside the base interest rate. Although the base rate is fixed, if it changes, the borrower stands to gain through a lowered floating interest rate," he added.
In some loan programs, individuals can also fix the interest rate under floating interest rates for a specified period and then reset it to fixed interest rates.