Fixed vs Floating Interest Rates
As a borrower, one of the most important consideration when choosing between loans is the Interest Rate (or Profit Rate in Islamic finance). The Interest Rate component of a loan itself can either be a Fixed or Floating (aka Variable) rate.
A fixed interest rate does not change throughout the duration of the loan. Because of this, the borrower knows exactly how much to pay in monthly installments every month. This is most suited for borrowers that do not want any surprises to their monthly commitments.
A floating interest rate is based on a Reference Rate (e.g. BLR, BFR, OPR, KLIBOR) that can change over the duration of the loan. This Reference Rate is controlled by the bank (e.g. BLR) or market determined (e.g. OPR) and can change at a moment’s notice, affecting a loan’s interest calculation. A change in interest payable could affect 2 things:
- An increase in the monthly installment amount
- An increase to loan repayment period
A typical floating interest / profit rate arrangement usually looks like this:
Reference Rate (+ OR -) x%
Together with the Reference Rate, the (+ OR -) component and the 'x%' determines how cheap/expensive the loan is. When comparing between different loans, borrowers typically place importance on the latter 2 components, as the Reference Rate component is typically similar between different banks. For example:
- Bank A - BLR (6.6%) - 2%
- Bank B - BLR (6.6%) - 2.1%
Using the above example, Bank B has the cheaper loan package. And the active interest rate at the time of calculation for Bank B would be 4.5%.
As a general rule, interest rates are lower in bad times and higher in good times. The most common option taken by borrowers today are Floating Rate loans due to the significantly cheaper interest rates at current levels compared to the Fixed Rate packages that are available today. But if you are looking for predictability, then Fixed Rate packages could be for you.
If you are unsure, make use of Loanstreet’s proprietary comparison wizard to decide on whether to go for Fixed or Floating Rate options. This way, you can compare the best packages both options have to offer.