Sometimes more number of options can create confusion in your mind. And this very fact also applies to car loan where lenders are coming up with attractive interest rates, flexible payment options, zero down payment schemes and plenty more to lure the customers. But the interest rate is something that grabs most of your attention as it is a key indicator of the cash outflow from your income and saving reserves. Higher the interest rate, higher will be the interest outgo and vice-e-versa. Car loan is offered on fixed as well as floating rate by the lenders these days. Floating rate, however, was available on home loan only in the earlier times. But now lenders like ICICI Bank, SBI and a few others are offering car loan on floating rate. In this article, we will let you know the difference between fixed and floating interest rates as well as tell you where and for whom these mechanisms can be applicable.
Differences between fixed and floating interest rates
The floating rate is a mechanism where the calculation of interest is made in accordance with the prevailing Floating Reference Rate (FPR), a benchmark rate on which all the banks price their floating rate loans. The rate will vary from time to time. While loan taken on fixed rate remains at a certain value throughout the loan tenure regardless of the variations in benchmark rate.
Floating rate is based on three components- Effective Rate, Benchmark Rate and Mark up or Mark Down. Effective rate is the actual interest rate on car loan that currently ranges from 9-12%, while benchmark rate remains slightly lower or higher than the actual rate. You can benefit if the benchmark rate goes below the actual rate if you opt for floating rate car loan. Mark up or mark down is the difference between the actual rate and benchmark rate.
Things to keep in mind
- For people not wanting to take risk, fixed rate of car loan is going to be a good option.
- Those who love to take the risk of interest rate fluctuation can go with floating rate of car loan. The option will be more useful if you successfully predict about the lowering rates in the coming years
- However, as car loan is given for a period of up to 7 years, it is advisable you go for floating rate. An upward trend in interest rate can take you off guard as the time period of car loan is quite shorter compared to home loan to deal with such uncertainty. Plus, there is no guarantee that banks will cut their interest rates despite the slashing of repo rate by the Reserve Bank of India. The proof being less than half of the benefit passed on to the consumers by the commercial banks of India in response to the 150 basis point cut in repo rate, the rate at which the central bank lends to scheduled commercial banks, in the last two years. Banks have cut interest rates by 60-70 basis points only during the period. (1 basis point=0.01%)