Students who study abroad rely on student loans. It is to bring to your attention that the interest rates charged on education loans are generally classified as fixed or floating. The interest rates and interest payable at the time of repayment determine the overall structure of the bank. The crucial consideration when opting for an education loan abroad is the interest rate. However, most of the students often get confused about floating or fixed interest rates.
Types of Interest Rate Loans
Fixed Interest Rate on Loan: As is clear from the term, fixed interest rates are "fixed" in nature, and you will pay the same rate of interest during the entire period of repayment. There will be no change in the interest rate that was set at the outset unless the market changes. Fixed interest rates are easy and understandable even by non-financial people, unlike variable or floating interest rates. However, fixed rates are always higher than floating rates.
Key Highlights about Fixed Interest Rates
Floating Interest Rate: Because of its inherent flexibility, changes in the Reserve Bank of India's repo rate and base rate have always had an impact on this type of interest rate. As a result, any shift in the economy will directly affect floating interest rates.
The difference between fixed and floating interest rates is that fixed interest rates are set and, hence, unaffected by fluctuations in the market. On the other hand, floating interest rates are more difficult to comprehend because they involve the base rate, repo rate, and marginal cost of lending rate, which have the greatest impact on interest rates on loans for education or other purposes.
Key Highlights about Floating Interest Rates
Why floating interest rates?
The floating interest rates give an individual the freedom to enjoy the market conditions and keep an eye on grabbing the best deal. For example, if there is a possibility that the RBI releases huge funds to banks, you can take advantage of it. The fluctuations in the interest rate vary depending on the RBI. However, the changes can revolve around a per-quarter cycle or up to a half-yearly cycle. The decreased rates make floating interest rates more lucrative in comparison to fixed interest rates. Due to this condition, students are choosing loans based on floating interest rates.
However, the RBI can increase the base rates, which can directly impact your interest payment, and you will end up paying more. This increment by the RBI is due to prevailing "market conditions."
Factors involved in the floating interest rate:
To better understand this term, let's look at the variables involved and how they affect it. MCLR (Marginal Cost of Lending Rate) and the repo rate set by the RBI are the main factors impacting interest rates. The fluctuation in the interest rate is caused by the increase and decrease in the repo rate.
How does MCLR affect floating interest rates?
The RBI has introduced the "Marginal Cost of Lending Rate," which is the lowest interest rate it offers to all banks, in an effort to make the loan process more democratic and transparent. This is the minimum lending rate below which a bank is not permitted to lend. MCLR replaced the earlier base rate system to determine the lending rates for commercial banks. RBI implemented MCLR on April 1, 2016, to determine rates of interest for loans.
The interest rates are now set in accordance with the relative risk factors of specific clients following the implementation of MCLR. Previously, banks took a while to adjust the lending rates for borrowers when the RBI lowered the repo rate. Banks are required to change their interest rates under the MCLR system as soon as the repo rate changes. The implementation aims to increase the transparency of the process banks use to determine the interest rate in advance.
Additionally, it guarantees the possibility of bank loans at rates that are fair to both banks and consumers. Banks compute the MCLR each month in order to be consistent with their lending procedures because they are unable to lend below the MCLR. Therefore, the cost of money determines the base rates that the banks charge, and it may have different consequences for borrowers.
How does the repo rate affect MCLR?
The rate at which the central bank (RBI) provides money to the commercial banks to cover their short-term funding needs and inflation is known as the repo rate, or repurchase rate. To put it another way, when the repo rate is higher, banks must pay the RBI a higher interest rate in order to obtain cash, and when the repo rate is lower, borrowing money is less expensive. Thus, it will be correct to say that the changes in the repo rate will have a direct impact on your loan interest. A cut in the repo rate will decrease the MCLR, and an increase will directly impact the increase in the rate of interest. However, the MCLR is influenced by factors other than the repo rate, such as operating costs and loan tenor.
Impact of the repo rate on determining the final interest rate: In this section, we will discuss the extent of the impact that MCLR and the Repo rate have on determining the final interest rate on education loans. Students taking loans from banks based on floating interest rates will be required to have MCLR and repo rate-based loans.
Let’s suppose a student has taken the loan at 8% MCLR and 4% interest on the spread value, which is constant. Then your interest rate will be 12%. By any chance, if the RBI decides to increase the repo rate to increase the flow of money in the market and the MCLR drops to 7%, then your new interest rate will be 11% on the loan per year. This example clearly indicates that market scenarios (not stock market scenarios) and repo rates impact the entire scene of floating interest rates. Borrowers have the option of receiving lower interest rates if they choose the floating interest-based loan over the fixed-rate loan.
How do I choose the best?
If we look at the entire scenario of floating interest rates, it comes with a reset period and a range of variations. During the reset period, the interest rates on your loan will be subject to revision; your bank will notify you of this in advance, and it will also be mentioned in your loan sanction letter. Every bank or lender’s reset period would be unique and differ from one another.
You can see the variation in timing of the reset period of interest rates. Some banks offer a one-month period for reset, and some offer a one-year period. It totally depends on the banks and the lenders. Along with the advantages, there are some drawbacks. Any increase will result in increased interest payments by the borrower.
There is no exact reason to say which of the fixed and floating interests will remain most appropriate for the students. Fixed interest rates will stay stagnant, while floating interest rates come with flexibility. Thus, it totally depends on the decision of the borrower, but considering the above factors will help you make an appropriate decision in the end.
If you need to learn more about foreign education loans, then contact the Education Loan Guru
By Education Loan Guru
