Floating Interest Rates in Education Loan

When you get an education loan, you will plan your monthly EMI and set a budget. But as a surprise to you, sometimes you will see a lower EMI to be paid; other times, it will be higher than your monthly budget. You might wonder what affects your education loan EMI. And here comes the concept of floating interest rates.

The floating interest rate is a kind of interest on loans highly dependent on the financial market conditions. As the name suggests, they float per the changes, sometimes favorable to the borrower and vice versa at other times.

Interest on education loans is usually calculated as floating. It means that in the 10 - 15 years repayment period, a student borrower will repay the EMI in irregular installments. While floating interest rates are better for loans with longer repayment periods, a fixed interest rate is best suited for short-term loans.

Difference Between Fixed And Floating Interest Rate

What is a fixed interest rate? In fixed interest rates, the rate of interest fixed at the time of taking the loan is what you will have to pay for the entire repayment period. There are no alterations, irrespective of changes in the market.

What is a floating interest rate? Floating interest rates, as evident from the name, have a floating nature and fluctuate with the market forces. The interest rate may increase or decrease multiple times during the entire duration of the repayment period. The RBI determines the base rate based on market dynamics, and the interest rates are pegged to the base rates.

While the sum of fixed interest rates is simple and doesn’t need much deliberation, floating rates are complex to predict the total sum of interest repayment. Consider the non-linear EMIs when calculating the monthly interest before taking an education loan with floating interest rates.

Read more about education loan interest rates here.

Floating Interest Rates For Abroad Education Loan

It is better to compare the floating interest rate for the education loan before finalizing your lender. Note that the effective interest rate is determined by the type of education loan and your profile’s strength.

Here is a comparison of different lenders and their *floating interest for education loans:

*Floating interest rates as of 01.12.2024

Why Do Borrowers Choose Floating Interest Rates?

Floating interest rates allow you to enjoy positive changes in the financial market. If the RBI decreases the margin of interest rates, the floating rate will be lowered. The lowered interest rates will apply until the next revision cycle, usually yearly, quarterly, or half-yearly.

However, if the RBI increases the marginal lending rate, the floating rate will be higher than you pay. But the chances are fewer since the overall economy doesn’t vary absurdly in a sporadic manner.

What is MCLR Rate Meaning in Floating Interest Rates?

The Marginal Cost of Funds Based Lending Rate, commonly called the MCLR, is the benchmark interest rate below which banks can’t lend. The RBI introduced it in 2016 to make the lending process more democratic and uniform for all lenders.

When the MCLR changes, the interest rate on loans linked to it also changes. This means the EMI amount you must pay will increase or decrease depending on the MCLR. A lower MCLR will lead to lower interest rates and, thus, lower EMIs for borrowers.

MCLR depends on factors like Repo rate, operating cost, cost of funds, loan tenor(duration of the loan), etc.

However, the MCLR got replaced by EBLR, or External Benchmark Linked Rate, in 2019. Although many lenders still follow MCLR, eventually the EBLR will be adopted by them.

To What Extent Do Floating Rates Affect Interest Rates?

Your education loan floating interest rate is either repo-based (RLLR) or MCLR based. It is calculated as MCLR+ A% or repo rate+ A%. Here, the “A” is constant, known as the premium percentage, and the MCLR or repo-based rates keep changing at certain intervals.

For instance, 

• 
  If a student takes a loan at 11% MCLR and A(constant)= 3%, the interest rate will be 14%
• 
  But if RBI decides to lower the repo rate to inject some liquidity into the market, and the MCLR drops to 9%, the new interest rate will be 12%

It’s a matter of market conditions and RBIs repo rate that decide the extent of fluctuations in floating interest rates. 

But, as mentioned earlier, it is not like a stock market; rates don’t change abruptly and unevenly. So, floating rates can benefit long-term loans, as paying a fixed interest rate may increase your repayment.

What’s the range of variation in interest rates?

• 
  The range of variation is from 0.25% - 0.50%.
• 
  The rate of change is not an abrupt number but a very minimal change.
• 
  The MCLR rates only change, not the premium percentage.

For example if your overall interest rate was 13.50%, then it can barely float between 13.25% - 14.0%.

Read more on how your education loan interest can change.

What is the Reset Period in Floating Interest Rates and How Often Does it Change?

The reset period is when the interest rates will be reset to the current rate based on market changes. The bank decides the reset period, and the borrower must carefully read the documents and convey that the reset period is acceptable to them.

• 
  The reset period will be mentioned in the sanction letter or the loan agreement
• 
  The rules about the reset period vary from one bank to another. Some banks give the reset period one month, while most banks keep the reset period to one year.

The rationale behind keeping a long reset period is that the benefit of a lower interest rate can be transferred to a borrower for a relatively long period. But in a long reset period, if the rates increase, the borrower has to pay a higher interest rate for a relatively long duration.

Plan your education loan repayment amidst the interest variations:

• 
  Big savings with smart repayments: education loan repayment strategies

• 
  How to repay your education loans faster?

• 
  How to plan your education loan repayment?

Calculation of Floating Interest Rates

Information Required to Calculate Floating Interest Rates:

You need the following information to calculate the floating interest rate:

• 
  Loan Amount: The total education loan you have taken.

• 
  Floating or Variable Interest Rate: The initial interest rate charged at the time of loan application, which can change according to market conditions.

• 
  Reference Rate: The benchmark interest rate or index on which the floating rate is based.

• 
  Margin: The fixed percentage added to the reference rate to calculate the floating rate.

• 
  Loan Tenure: The length of time over which the loan has to be repaid.

Steps to Calculate Floating / Variable Interest Rate:

To calculate the interest on floating interest rates education loan, follow these steps:

• 
  Calculate the floating rate of interest: Add margin to the reference rate. For example, if the reference rate is 4% and the margin is 2%, the interest rate would be 6%

• 
  Then calculate the monthly interest rate: Divide the floating rate by 12 to obtain the monthly interest rate. For example, if the variable interest rate is 6%, the monthly interest rate would be 6% divided by 12, which is 0.5%.

• 
  Calculate the monthly interest payment: Multiply the monthly interest rate by the outstanding loan balance for each month. Please note that the outstanding loan balance is the loan amount minus the principal amount repaid in previous months. This calculation gives you the interest of the monthly payment.

• 
  Calculate the Monthly Principal Payment: Subtract the interest payment calculated in the previous step from the total monthly payment to find the principal payment.

• 
  Similarly, calculate the interest for the loan tenure and sum up the total interest paid.

Please note that this is a simple form of the calculation and the actual interest rate calculation may involve compound interest and other additional charges based on the terms and conditions of the loan. Also, as the floating interest rate changes over time, the calculation may need to be adjusted for a renewed interest rate.

Pros of Floating Interest Rate in Student Education Loan

Let us understand some of the advantages of floating interest rates in student education loans:

• 
  Low interest rates
• 
  More affordable during the first year of payment
• 
  Possibility to reduce the interest rate
• 
  Floating interest rates are lower than fixed rates for longer periods
• 
  Savings are more during the long tenure of loan repayment
• 
  A dip in interest rates results in a decrease in the monthly interest rate

Cons of Floating Interest Rate in Student Education Loan

Now, let us understand some of the disadvantages of floating interest rates in student education loans:

• 
  Unpredictable interest rates
• 
  The total amount of interest may change due to fluctuation.
• 
  The uncertainty may create financial problems for students.
• 
  The uncertainty can also make the situation stressful for students.
• 
  Chances of paying more interest are always possible.
• 
  Overpayment of interest amount may increase the financial burden.

Fixed or Floating Interest Rate Which One is Better?

There is no fixed rule to assess which is better; it depends on the market changes and your financial choices.

Floating rates benefit the student if RBI policy makes the interest rates low. In such cases, the flexibility of interest rates reduces the burden on the EMIs, which is a significant relief to students who start earning after completing the course.

But if the market is adverse, the floating interest rate can add up to your debt. It is better to see both sides of floating interest rates to make an informed decision. The table below compares the pros and cons of floating interest rates: 

If assessed from the present state of affairs, India is on track to witness colossal growth, and RBI will keep the interest rates lower to encourage lending. So, going with the floating interest rate will be conducive for the times to come. But again, everything reverses if the market conditions turn back unexpectedly.

A crucial action is evaluating the market conditions before applying for an education. Take our help and ease your work. We will do the market research for you and suggest the best loan option while you are in the comfort of your home.

Frequently Asked Questions

Can I choose floating interest rates over fixed for every lender? 

 

Generally, the interest rates for education loans are floating for all lenders. However, some lenders would charge a fixed interest for education loans. Contact your lender to clarify whether you can get an education loan at a floating interest rate. 

Are floating interest rates applicable to secured and unsecured education loans?

 

The floating nature of interest applies to secured and unsecured education loans alike. However, compared to unsecured loans, secured loans will have a lesser interest rate due to the involvement of collateral security. As the interest rate is MLLR + A% (A= component decided by the lender), the lender’s component in the total interest rate will be slightly lesser for secured education loans. 

What are the major changes that affect the floating interest rates?

 

The floating rate of interest in loans is affected by many factors, some of which are unpredictable. Changes in the following are some factors will affect the interest rate of loans: 

• Economic conditions
• Reserve Bank policies
• Market competition
• Government policies and regulations
• Flexibility of the financial market

Is it possible to predict fluctuations in interest rates?

 

To a great extent, the market conditions are predictable for interest rates. But unpredictable situations like a pandemic or war may influence economic activities. In such cases, the fluctuations are beyond the predictions by experts. 

How can I compare two education loans with floating interest rates?

 

It is easier to compare the floating interest rates of two lenders. The effective income rate is determined by adding the MCLR and a fixed component. The lender determines the fixed component based on various factors. You can compare the effective interest rates and choose the better education loan option.