Fixed vs Floating Rates on Car Loan
Today, it has become difficult for a borrower to select among the features and combinations that are being offered by banks and NBFCs on every kind of loan. Competition among banks and financial institutions has led to the development of attractive loan products.
Availability of different product makes it difficult for a customer to choose a product that fits his/her budget, the best. There is a need to do a little bit of research and compare the product in order to get the best car loan. There are two types of car loans offered in the market: fixed and floating rate interest car loans.
Differences: Fixed vs Floating Rates on Car Loan:
Floating interest rates loan is that whose interest is computed as per the existing Floating Reference Rate(FRR), which is the benchmark used by all banks to price their floating rate loans. This rate may vary periodically.
Floating interest rates has 3 components:
1. Effective Rate: It is the actual rate applicable to a loan.
2. Benchmark Rate: It is only a reference rate which is less than the actual rate.
3. Mark up and Mark Down: It is the difference between the benchmark and the actual rate.
Fixed interest rate loan remains fixed throughout the tenure of loan irrespective of the changes in the benchmark rate.
Let’s assume effective rate is 14 percent and the benchmark rate is 12 percent. Therefore, the markup rate becomes 2 percent.
Usually, banks change the effective rate by changing the benchmark rate or mark up rate. In case, the bank reduces the benchmark rate by 1 percent then the effective rate will drop by 1 percent. Now the effective rate will be 13 percent i.e. benchmark rate (11) plus markup rate (2).
Similarly, the bank can also change the interest rates by changing the markup rate by 1 percent when the benchmark remains the same. Now the effective rate will be 13 percent i.e. benchmark rate (12) plus markup rate (1). Normally, the interest rates drops are one by changing the markup rate only.
Factors to consider while choosing the type of loan
• Those who wish to maintain a steady payment should avail a fixed interest rate car loan
• Those who are ready to take the risk, the prediction of the trend of interest rates in the future years is the basis of consideration. If there is the possibility of an upward trend in the interest rates, then it is better to stay locked in a fixed rate loan. If trends show a downward shift in interest rates, then opting for a floating type may be profitable in the long run.
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