The total cost of a loan mainly depends upon the interest rate that is charged on it. If the tenure of the loan is above one year, then the interest rate variation during the tenure of the loan can have significant impact on your total interest payment. This becomes critical especially when you take a floating rate loan and see the interest rate rise significantly after a year. However, if you take a fixed rate loan at a time like now when the interest rate is close to the lowest levels seen in last two decades then it will keep your interest outflow low and deliver better saving than a floating rate loan.
Here's how.
Signs of reversal of interest rate cycle upwards
The country's largest public sector bank, State Bank of India (SBI), announced on December 17, 2021, that it had hiked its base rate by 10 basis points (bps), signalling the start to the end of regime of low interest rates. Besides being a reference rate for borrowers, the base rate also works as an indicator of the direction of the overall interest rate in the economy.
A rise in base rate indicates that the falling interest rate trend is finally reversing and going forward we may see a few more hikes in interest rates. Crude oil (WTI) prices after falling to $65 level in beginning of December have now risen close to $73 on December 23 which indicates the revival of global demand. If the impact of Omicron variant of Coronavirus on global economy does not stretch for long period and remains manageable then with a double digit rise in WPI (Wholesale Price Index) in India which may later have spillover effect on CPI (Consumer Price Index), the likelihood of RBI raising the rate in coming future cannot be ruled out.
Car loans and personal loans at fixed rate
A good part of retail loans which are available on fixed rate come in the form of car loans and personal loans. While not every lender is offering these loans at fixed rate, but a good number of them do. "Public sector banks usually offer personal loans on floating interest rates whereas most private sector banks and NBFCs offer personal loans on fixed interest rates," says Sahil Arora - Senior Director, Paisabazaar.com.
The story is similar when it comes to car loans as well. "While most PSU banks offer car loans at floating interest rates, State Bank of India offers car loans at fixed interest rates. Private sector banks and NBFCs usually offer car loans at fixed interest rates," says Arora.
*Further interest rate concession of 0.20% on purchase of electric vehicle (Green Car Loan)
**0.25% interest rate concession for existing housing loan borrowers and corporate salary account holder. 0.05% concession on interest rate to women & armed forces personnel subject to minimum floor ceiling of RLLR.
Fixed vs Floating rate taken from respective websites of the banks
Rates and charges as on 16th Dec 2021, Source: Paisabazaar.Com
How fixed rate loans can save interest
During the long tenure of 5-7 years which is usually the case with personal loan and car loans if the interest rate starts moving up a fixed rate loan will help you save significant interest amount.
If you compare a car loan of Rs 10 lakh at fixed interest rate of 7.5% and a floating interest rate with starting rate of 7.5% but with a rise of 0.5% interest, within a tenure of 5 years your interest outgo will be only Rs 2.02 lakh in the fixed rate option while it will be Rs 2.20 lakh in the floating rate option. If the interest rate hike is more than 0.5% in initial years, then the interest outgo could be much higher.
The move to go for fixed rate loan will be more beneficial when you are selective in picking the lender and the interest rate. "As fixed rate loans carry higher interest rate risk for the lenders, they usually charge higher interest rate on fixed rate loans than the floating rate ones to cover the higher risk," says Arora.
However, when you compare the interest rate across lenders you can easily find many lenders offering a fixed rate loan at competitive rates. For instance, Canara Bank's lowest interest rate on a floating rate car loan is 7.30% while you can get the fixed rate loan from SBI at 7.25%. Similarly, Federal Bank's minimum floating rate on its car loan as 8.5% while you can get a fixed rate loan from HDFC Bank at 7.95%.
Similarly, you can get a fixed rate personal loan from SBI at 9.6% if you hold a salary package account with the bank. You will have to pay a minimum interest rate of 10.5% if you go for a floating rate personal loan from Bank of Baroda as per its website. So if you do some research you can easily find a lower fixed rate option for car loan and personal loan that works for you.
Use a personal loan instead of used car loan at higher rate
If you are planning on taking a used car loan, then you need to consider all your options critically. "Lenders charge higher interest rates on used cars as the credit risk associated with lending for used cars is higher than new cars. Interest rates of used car loans usually range from 8.75% p.a. to 16% p.a. depending on the condition, age and segment of the car," says Arora.
Instead of opting for a user car loan, one can think about availing to personal loan to finance the vehicle purchase. "Some banks and NBFCs in fact charge lower interest rates on their personal loans than used car loans. Hence, those planning to buy used cars through loans can also consider availing a personal loan," says Arora.
Moreover, a personal loan may enable you to get higher amount of finance than a used car loan. "As lenders usually finance up to 70% of the value of used car through car loan, availing a personal loan to finance used car can let them to avail bigger loan amount for longer tenure," says Arora.
