For MSMEs in India, getting a business loan(secured/unsecured) can be a very important step when it comes to scaling their daily operation capacity or investing in new programs etc. However, what becomes decisive in the borrowing of a business loan is the interest rate specifically, whether it is fixed or floating. Understanding the differences, pros and cons of these two types of interest rates can help MSME owners to make right calls and effectively manage the finance opportunities. A new MSME entrepreneur may be unaware of these 2 different interest rate types and hence we are stepping forward to be a helping hand in educating on the same.
This article delves into the key differences between fixed and floating interest rates, factors to consider when choosing between the two, and how MSMEs can align this choice with their business needs and goals.
Also read: Empowering Women Entrepreneurs: The Rise of Business Loans Tailored For Women
What Are Business Loan Interest Rates?
Business loan Interest rate represent the cost of borrowing money and are expressed as a percentage of the loan amount. For businesses, the interest rate determines how much they will repay in addition to the principal amount. Indian financial institutions typically offer two types of interest rates for business loans:
1. Fixed Interest Rates: The rate remains constant throughout the loan tenure, providing predictable EMI payments.
2. Floating (or Variable) Interest Rates: The rate fluctuates based on market dynamics and changes in external benchmarks like the Repo Rate set by the Reserve Bank of India (RBI).
Main Difference: Fixed vs Floating
Aspect |
Fixed Interest Rate | Floating Interest Rate |
| Rate Stability | Remains constant throughout the loan tenure | Varies with market conditions |
| Varies with market conditions | Predictable, making it easier to plan finances | EMI amounts fluctuate, offering less stability |
| Cost | Higher initial rates | Generally starts lower but may increase later |
| Impact of Market Rates | Not influenced by market rate changes | Directly influenced by changes in benchmarks |
| Prepayment Charges | Often higher | Typically lower or nil |
Factors to Consider When Choosing
Selecting between fixed and floating interest rates involves evaluating various aspects of your business's financial needs and the economic environment. Below are some critical factors to consider:
1. Loan Tenure
● Short Tenure Loans: Fixed interest rates might be preferable for shorter loans since the impact of market rate fluctuations is minimal over a brief period. Predictable repayments provide ease in cash flow management.
● Long Tenure Loans: Floating rates may be more beneficial for longer tenures as market rates often vary over time. While there is a risk of rate increases, borrowers can also benefit if rates decline.
2. Market Conditions
● Rising Interest Rate Environment: Whether the market goes up, down or sideways a business owner who opted for fixed rates can be at ease however floating rates opters would be directly impacted by the market on their EMI payments to be done.
● Declining Interest Rate Environment: Floating rates can be advantageous during periods of falling interest rates, as the loan's cost may reduce over time, thereby lowering EMIs.
3. Risk Appetite
● Low Risk Tolerance: Entrepreneurs who prioritize financial stability and wish to avoid uncertainties may opt for fixed rates. This ensures that EMI amounts remain consistent, aiding in budgeting and financial planning.
● Higher Risk Tolerance: Business owners with a higher appetite for risk and confidence in managing fluctuating costs can consider floating rates. While these rates may lead to savings during a declining market, they carry the potential for increased costs if market rates rise.
Also read: Loans For Entrepreneurs Increased To ₹20 Lakh By Centre
Additional Considerations for MSMEs in India:
● Cash Flow Predictability: MSMEs with variable cash flows may benefit from fixed rates to ensure steady repayment amounts. On the other hand, those with surplus reserves might leverage floating rates for potential cost savings.
● Prepayment Flexibility: If your business is likely to prepay the SME loan, floating rates may be advantageous due to lower prepayment penalties.
● Loan Size: For large-sized loans, the type of interest rate can significantly impact total repayment. Assess the projected financial impact carefully.
Conclusion:
Choosing between fixed and floating interest rates needs a proper analysis of one’s business’s financial stability, growth wants, and the current economic scenario. Fixed interest rates offer stability and predictability, making them ideal for businesses that prioritize consistent budgeting and lower risk capability. Floating rates, on the other hand, present opportunities for cost savings during favourable market conditions but require tolerance for fluctuations. Once both rate types are understood based on this article the business owner could do the due diligence to take a decision on which direction to move.
For MSME business owners in India, your cash flow patterns, risk tolerance, and growth outlook is needed. Consult with a financial advisor or loan provider to gain clarity on the best option for your business and don’t consider this article as financial advice. By making an informed decision, you can ensure that your business’s financing strategy supports its long-term success.
