A fixed interest rate on a loan is an interest rate that remains the same either for the entire term or for part of the term of the loan i.e. it doesn't fluctuate for the fixed rate period of the loan. This brings in certainty in repayment structure and allows the borrower to predict & plan their future payments. Nowadays most banks allow fixed interest rate for only for the first 3 to 10 years of the loan tenure. Thus, at the end of such fixed term, the borrower has to either choose a new fixed rate of interest from the rates available at that time or change to a floating interest rate.

A floating or variable interest rate on a debt instrument changes with the rest of the market or an index. The interest charged on outstanding balances varies as market interest rates change. These loans are usually tied to a base rate and have a floating element. As the base rate changes depending on the market conditions, the floating interest rate is also revised accordingly. This makes it difficult to budget with floating interest rate. Example, you take a home loan on floating rate basis. The interest rate payable as per sanction is Base Rate + 1.75%. Present base rate being 9.00%, payable interest rate will be 10.75% (9%+1.75%). If base rate is increased by bank after 1 year to 9.50%, then your interest rate will automatically increase to 11.25% (9.50%+1.75%).

In general, if the prevalent rate of interest is comparatively low and market trend indicates an increase, then it is advised to freeze a fixed interest rate on your loan. However, if existing interest rates are on the decline, then it is advised to choose a variable rate of interest on the loan.

It has been noted that in the short term, fixed interest rates are usually higher than the floating rate, due to the risk taken by the bank for losing if the interest rates go up during the loan tenure. However, the borrower must decide keeping in mind the repayment period of a loan. The longer the repayment period, more the impact a change in interest rates will have on your payments.