Apply
for
Financial Planning
 |
 |
 |
We will not disclose your contact details to anyone without your permission.
+91 1800-180-7424 (Free Call)
+91 (0)124-478-0222
Monday - Saturday 9:30AM to 6:30PM IST
+91 (0)124-478-0222
Monday - Saturday 9:30AM to 6:30PM IST
Other Popular Articles
Posted On: 08-Feb-2010
Interest Rates - Basics That All Borrowers Must Understand
Many of us take loans and pay EMI according to the term of the loan and the interest charged. But, how comfortable are we with our basic knowledge of interest rates? Here we share some basic points on interest rates relevant relevant for first time borrowers.
What is an interest rate?
The yearly price that a lender charges a borrower for obtaining a loan is the interest rate. Usually, this is expressed as a percentage of the total loan amount.
Who decides the rate?
In India, interest rates are set by our central bank, the Reserve Bank of India (RBI). Depending upon factors like inflation and prevailing economic conditions, the RBI can adjust interest rates as needed to promote growth or to cool the economy. The rate set by the RBI is the basis for how retail banks set the rates they charge consumers like us for home loans, car loans, business loans etc. If the RBI changes rates, then banks will also reset their rates on some types of loans.
Types of interest rates
- Fixed rate: This type of interest rate remains same throughout the tenure of the loan, regardless of the prevailing market conditions, i.e., regardless of whether market rates are going up or down. For instance, when you take a car loan, the rate of interest is usually fixed for the term of the loan. Most short-term loans are often fixed interest rate loans.
- Floating rate: This type of interest rate changes based on the prevailing market conditions. For instance, when you take a home loan, you pay a fixed rate of interest for the initial two to three years, and then you pay a floating rate of interest which is based on the then prevailing market scenario. Most long-term loans such as home loans are usually floating.
| Type of Loan | Type of interest available | Comments |
| Home Loan | Fixed and Floating | Can be Fixed for the first 2 to 3 years, after that it is Floating. |
| Personal Loan | Fixed | The interest rate is mostly Fixed throughout the tenure. |
| Auto Loan | Fixed and Floating | Mostly Fixed rate of interest. |
| Credit Card | Fixed | Fixed rate of interest which is specified in the contract with issuer. |
| Education Loan | Fixed | Mostly Fixed rate of interest. |
| Loan Against Gold | Fixed | Fixed rate, similar to a personal loan. |
Can I choose a type of rate?
Depending upon the type of loan you are taking, sometimes you can choose between fixed and floating rate of interest. But mostly you do not have a choice. For instance, it is rare that you will get a pure fixed rate home loan in India. After a period of the 2 to 3 years, you will be charged a floating rate of interest. Your EMI payments will change depending upon the change in rate. On the other hand, when you take a 3-year auto loan, the rate of interest you are charged on it is fixed. For the entire tenure of the auto loan, your EMI would be the same.
Can I switch from one type of rate to another?
Yes, you can convert floating rate home loan into a fixed rate loan with no extra charges. However, to convert a fixed rate product to a variable rate product, most banks will charge a small fee. The swap can be done any number of times and at any point of time.
Impact of interest rate on EMI
Impact of fixed and floating rate of interest on the EMI differs. For instance, Karan has bought a house, and taken a loan of Rs. 10 lakh for a period of 15 years at a fixed rate of 8.5%. Lets say, for the first three years, the rate of interest on his loan is fixed. Then his EMI for the first three years is Rs. 9,847. After three years, the rate is reset to 9%. Then, his EMI would come to Rs. 10,142.
Key points to remember
- Understand what type of rate you are getting: It is important for you to know what type of rate are you being charged and if it will be subject to change during the tenure of the loan.
- Review your rate periodically: You should timely review your interest rate as it could be subject to change. You might be able to get a cheaper rate if interest rates have come down.
- Compare and negotiate: It is advisable that you run a thorough search for interest rates on loans on the internet and also via bank branches. In most cases, banks have a discretion on what they can charge you so negotiate.
If you liked this article, you
might also want to read:
Comments
