If you are considering taking out a loan, you may have heard the terms “fixed interest rate” and “floating interest rate”. When you take out a loan, the interest rate is usually set in one of two ways. Fixed interest rate and Floating interest rate.
How are loan interest rates determined in Nepal?
The interest rate of a loan is generally determined by banks on the basis of two components: base rate and premium rate.
Base Rate
The base rate is the minimum rate at which a bank can lend. It reflects the bank’s cost of funds, interest paid on deposits, the cost of maintaining statutory reserves with Nepal Rastra Bank (NRB), operating costs, and a return on assets. Banks publish their base rate regularly. It generally falls when market liquidity is comfortable and rises when funds are tight.
Premium Rate
A premium is added on top of the base rate, based on the borrower’s risk profile and the loan type. Secured loans such as home loans typically carry a lower premium than unsecured lending.The floating rate is calculated as:
Floating Interest Rate = Base Rate + Premium
Under NRB rules, once the premium is determined and stated in the approved loan documents, the bank cannot increase it afterwards. Only the base rate component moves.
What Is a Fixed Interest Rate?
The fixed rate stays fixed for a period of time and is unaffected by the market or any changes to the base rate. The rate is fixed at disbursement for a lock-in period, which is typically 5, 7 or 10 years depending on the product. EMI is calculated once and remains constant throughout the tenure.
Advantages of Fixed Interest Rate
EMI stays constant: EMI will remain constant from the date of disbursement till the end of lock-in period.
Not affected by interest hike: Increase in the base interest rate during lock-in period will not affect the loan.
Disadvantages of Fixed Interest Rate
Higher interest at the beginning: Fixed interest rates are usually higher than floating interest rates.
No benefits when interest rate falls: Decrease in base interest rate will not favor the borrower during lock-in period.
What Is a Floating Interest Rate?
A floating interest rate, also called a variable rate, moves in line with the bank’s published base rate.The premium stays constant while the base rate component is reviewed periodically, in line with the bank’s policy and NRB directives.When the base rate falls, the rate on the loan falls; when it rises, the rate rises. Banks publish their rate schedules regularly, so the applicable rate can be verified at any time.
Advantages of a Floating Interest Rate
Initial rate is low: Usually the initial rate will be low compared to the fixed rate.
Rate cuts are automatically passed on: Any decrease in the base rate implies an automatic interest rate cut.
Disadvantages of Floating Interest Rate
Variable EMI: The liability to repay becomes higher as the base interest rate increases.
Repayment amount unpredictable: The amount of repayment cannot be predicted in advance.
Need for constant monitoring: It is necessary to check the relevant rate from the published schedule.
Fixed vs Floating: Key Differences
| Feature | Fixed Interest Rate | Floating Interest Rate |
| Rate movement | Locked for the agreed period | Moves with the base rate |
| Starting rate | Usually higher | Usually lower |
| EMI predictability | Constant during lock-in | Varies with rate revisions |
| Effect if rates fall | No change during lock-in | Passed on automatically |
| Effect if rates rise | No change during lock-in | Effective rate increases |
| Review requirement | At end of lock-in period | Periodic |
Research and Choose Wisely
Whether you are looking for a Home Loan, Auto Loan, or any other loans, then do proper research and select the interest rate wisely. Rather than selecting the loan based on their interest rates, compare the structure of interest rates, base rate, premium, period of repayment, EMI, total cost of interest, charges, early repayment terms, and other terms and conditions. The interest rates and terms and conditions of the loan may change according to market conditions and relevant regulations; therefore, one needs to get the updated interest rate details.
