How Rising (or Falling) Interest Rates Could Affect Your Next Loan?

Interest rates decide how much extra you pay on a loan. Higher rates mean bigger EMIs, while lower rates help you save money. Understand how rates work before borrowing.

1. Monthly Payment Variations

When you borrow money, the interest rate determines how much extra you pay on top of the amount you borrowed. A higher interest rate means higher monthly payments, while a lower rate means lower costs. Let's see how this works with an example.

Example: Saksham’s Loan

Saksham wants to borrow ₹5,00,000 for 5 years. Here is how the interest rate affects his monthly payments:

Note: These figures are approximate and may vary based on the lender's terms.

As shown, a 2% increase in interest rate raises Saksham's EMI by ₹500 and the total amount paid by ₹30,000. Even small changes in interest rates can significantly impact your monthly budget and the total amount you repay. Therefore, it is important to consider the interest rate when taking out a loan.

2. Loan Affordability and Eligibility

When you apply for a loan, banks check how much you can afford to pay every month. This is called loan eligibility. It depends on your income, current loans, and the interest rate. If the interest rate increases, your monthly payment (EMI) becomes higher. 

This means you may not be able to borrow as much. If the rate goes down, your EMI becomes lower, and you may be able to borrow more.

Example: Karan’s Loan Eligibility

Karan earns ₹60,000 per month and has no other loans. He wants to take a loan for 20 years. Banks usually allow EMIs up to 50% of income, so Karan can pay up to ₹30,000 per month. Here is how interest rates affect the loan amount he can get:

Note: These figures are approximate and may vary based on the lender's terms.

As you can see, higher interest rates reduce the loan amount Karan can afford. So, it is important to consider interest rates when planning your loan.

3. Impact on Fixed vs. Variable Rates

When you take a loan, you can choose between two types of interest rates: fixed and variable.

• Fixed Rate: The interest rate stays the same for the entire loan period. This means your monthly payments (EMIs) will not change, making it easier to plan your budget.
  
  
• Variable Rate: The interest rate can change during the loan period, depending on market conditions. This means your EMIs can go up or down, which can be both an advantage and a risk.

Example: Varun’s Loan

Varun wants to borrow ₹10,00,000 for 10 years. He has two options:

Note: These figures are approximate and may vary based on the lender's terms.

With a fixed rate, Varun's EMI stays the same. With a variable rate, if the interest rate increases, his EMI and total repayment will go up. So, it is important to consider the type of interest rate when choosing a loan.

4. Refinancing Opportunities

Refinancing means replacing your current loan with a new one that has better terms, like a lower interest rate. This can help you save money by reducing your monthly payments or paying off your loan faster. However, refinancing may involve some costs, so it is important to consider if the savings outweigh the expenses.

Example: Jatin’s Refinancing Opportunity

Jatin has a ₹6,00,000 loan at 10% interest for 10 years. He is paying ₹8,000 per month. After 5 years, he finds that interest rates have dropped to 8%. He decides to refinance his loan to take advantage of the lower rate.

By refinancing, Jatin reduces his EMI by ₹500 and saves ₹30,000 over the next 5 years. This shows how refinancing can help you save money if interest rates drop.

Before refinancing, make sure to check if there are any fees or penalties involved. Also, consider how long you plan to keep the loan, as refinancing may not be beneficial if you plan to pay off the loan soon.

5. Economic Indicators and Loan Decisions

When you apply for a loan, banks look at the country's economic health to decide the interest rate and whether to approve your loan. This is because economic conditions affect how risky it is to lend money.

Key Economic Indicators:
 

• GDP (Gross Domestic Product): Shows how well the economy is doing. A growing GDP means more jobs and income, making loans safer for banks.
  
  
• Inflation: Measures how prices are rising. High inflation can lead to higher interest rates because money loses value faster.
  
  
• Unemployment Rate: Shows how many people do not have jobs. High unemployment means more people might struggle to repay loans, so banks may raise interest rates or be more cautious.

Example: Yash's Loan

Yash wants to borrow ₹8,00,000 for 15 years. The bank checks the economy:

In this case, the economy is doing well, so Yash gets a loan at a reasonable interest rate. But if the economy worsens, the bank might increase the interest rate or deny the loan.

Conclusion

Interest rates affect your loan payments and eligibility. Higher rates mean higher EMIs, while lower rates save money. Choose fixed or variable rates wisely and check the economy before borrowing.

FAQs

1. How do rising interest rates affect my loan EMI?

Rising rates increase your EMI, making your loan more expensive.

2. Should I choose a fixed or variable interest rate?

Fixed rates stay the same, while variable rates can change – pick based on your risk tolerance.

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About the Author

LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?