Fixed Interest Rate vs Floating Interest Rate for Education Loan

Students when applying for an education loan often explore multiple options to fund their education with the best possible interest rates available in the market. But when it comes to choosing between fixed and floating interest rates, they end up being confused about the same. It is one of the toughest decisions to choose between fixed and floating interest rates. Students often assume that the banks offering fixed interest rates are better, which is incorrect. Students must acknowledge the fact that the fixed interest rate offered by the banks is not always a good deal and consider floating interest rates not always a bad deal. This article will wrap all the information on fixed vs floating interest rates and will give a better insight into which one is better.

1. Fixed rates: Fixed rates are defined as the interest rate which remains the same throughout your loan tenure i.e. the monthly EMIs you have to repay are fixed as per the loan tenure. Fixed rates are not subject to change even if there are any fluctuations or changes in the financial market trends. 

2. Floating rates: Floating rates are defined as interest rates that are uncertain and volatile in nature. Floating rates are subject to change due to financial market conditions. RBI determines the base rate based on various economic factors. So, when the base rate changes, the interest rates are also revised accordingly. Therefore, if your loan is sanctioned at the X interest rate, the rate next year tends to change more or less. 

Refer to this chart above to have a clear understanding of how fixed rates and floating rates differ. So, most of the time banks do not mention the concept of fixed rates and floating rates. They do not consider explaining how they are subject to change according to the financial market trends. But if you go through WeMakeScholars, our financial officer will give you a clear insight of the abroad education loan interest rates and will also guide you throughout the loan process. 

So, every bank has a base lending rate like MCLR i.e. the marginal costs of funds. This base rate is decided by the banks and is dependent on the cost of funds. It is a minimum lending rate below which banks are not allowed to lend money. As banks are not allowed to lend money below the MCLR percentage figure, they are required to calculate MCLR on a monthly basis that MCLR rate is used for the new loans which are sanctioned in that particular month. 

Repo rate refers to the rate at which the Reserve Bank of India (RBI) lends money to commercial banks. The commercial banks borrow money by selling their securities to the Reserve Bank of India to maintain liquidity in case of inflation or in the event of any shortfall of funds.

A floating rate is an interest rate that changes according to financial marketing conditions. These rates are also known as variable rates as the interest rates change periodically. When students opt for floating interest rates, they might have observed an MCLR plus X% or repo rate plus X% on their sanction letter. Few banks like the Bank of Baroda (BOB) use different terminology for the MCLR rate which is BRLLR i.e. Base Repo Linked Lending Rate. So, they calculate BRLLR plus X% as the floating interest rate. Therefore, here the X% is constant throughout the process and the floating component will be MCLR or repo rate. 

For example: 
At the time you received your sanction letter, MCLR rate is 7%
then your today’s interest rate would be MCLR + 2% i.e. 9%.
In case of change in the MCLR rate, as it is subject to change according to the financial market trends if the MCLR becomes 6.5%, then your floating interest rate would be MCLR + 2% i.e. 8.5%. Similarly, if the MCLR increases to 7.5%, then your floating interest rate would be MCLR + 2% i.e. 9.5%.

How frequently does the floating rate change?

Most people assume that floating interest rates and the share market works similarly. But it is incorrect as floating interest rate changes periodically i.e once a month whereas the rates in the share market change every day. So, even though banks are required to calculate the MCLR or repo rate every month, it may or may not change the applicant’s interest rate every month.

When students opt for a bank charging a floating interest rate, they are confused about at what percent the rate may fluctuate i.e how much can be the expected increase or decrease. Students must understand that banks do not change the premium percentage i.e. the Floating Component is (MCLR/Repo rate + 2%) where 2% is the premium percentage and banks cannot increase or decrease it throughout their tenure. The floating component i.e. MCLR or repo rate changes on an average of 0.25%-0.5% on an annual basis. 

If you are having trouble understanding the concept, go through our 6th episode of Loanflix Season 2 where the Co-founder of WeMakeScholars, Ms. Damini Mahajan has explained the whole concept of fixed vs floating rate with suitable examples. As explained earlier, WeMakeScholars is a Government funded organization and we do not charge any fees for our services. So, if you are looking for an abroad education loan, connect with our financial officers to receive professional guidance throughout your education loan process.

1. Refer to your sanction letter or loan agreement where the “reset period” would be specified

2. The reset period specifies the time your interest rate would be updated. Most of the banks set down the time as 1 yr reset but few banks allot it as a 1-month reset.

3. So, if your reset period is set at 1 yr, the MCLR rate of the time you got your loan sanctioned will be applicable for the whole year. For eg: If you got your loan sanctioned in the month of January 2022, then your MCLR rate would be updated after 1 year i.e. in January 2023.

Note: Even if the MCLR rate changes in the next 2-3 months, it would not affect your interest rate.

4. If your reset period is set at 1 month, the MCLR rate of the time you got your loan sanctioned will change every month. For eg: If you got your loan sanctioned in the month of January 2022, then your MCLR rate would be updated after every month i.e. in February 2022.

As we know, the floating component may increase or decrease with the change in the financial market conditions, they are expected to go down in the near future as RBI is putting some effort to bring down the credit value and make it cheaper. Whereas fixed rates are usually higher than the floating interest rate as the interest rates are based on an expected value of future changes. 

So, if a student opts for a fixed interest rate, there is no risk associated with it as it is not affected by the change in the financial market conditions but a student must also consider that there is no gain as well. So, if in the future the economy gets much better and cheaper, the student will not reap any advantage from it. 

Therefore, there is no specific solution on which one is better as it depends on a lot of external factors which include RBI policies and guidelines, how much money the bank acquires, and definitely a pinch of luck.

In most cases, students have seen their peers who were on floating interest rates being charged much lesser interest rates as the interest rates are decreasing down the lane. In this case, students who are willing to change from a fixed interest rate to a floating interest rate can go for a refinance. It is also known as a takeover or balance transfer in India. With the help of refinancing, the student can move their loan to the cheapest option available in the market. But if you go via WeMakeScholars, the bank’s processing fee will be waived as we have special approval for that. 

If you are still wondering what is the best way to refinance student loans, watch our 5th episode of Loanflix season 2 on - “Education Loan Transfer for a better rate of interest” to understand better.

In India, there are very few banks with fixed interest rate options as most of the banks offer only floating interest rates. So, most of the students may really not have a choice unless they qualify for all the options available in the market. So, students who are planning to study abroad and are willing to know the correct options with accurate information, connect with our financial officer to seek professional guidance throughout their loan process.