Personal Loans, Home Loans or Business Loans are great ways to fund your desires, needs, aspirations and emergencies. At times you plan to buy things that are unaffordable in one go, or at times you are faced with a situation that requires a generous amount of funds – be it a planned or unplanned expense, loans are a great way to offer liquidity and money when it is needed the most.
A Business Loan is an ideal and preferred way to arrange funds for your business. A business owner can put this to good use by investing in long-term assets to meet working capital requirements, fund expansion plans, invest in more research and development, and hire human resources. This unsecured credit instrument helps a business owner sail through financially challenging times or be able to reach greater heights in their business.
Business Loans need to be repaid in equated monthly instalments, also known as EMIs. Many factors affect the EMI amount you will pay each month. The duration of your loan, your loan amount and most importantly, the Business Loan interest rate applicable. The type of business loan interest rate opted for – fixed or floating, also affects the EMI. External changes in the repo rate, monetary policy and other decision-making by the RBI impact the interest rate, thereby impacting the EMI.
Types of Business Loan interest rates
There are two types of Business Loan interest rates
Floating Business Loan interest rates
Under a floating rate, Business Loan interest rates vary in accordance with changing repo rates. This means that the interest rate will vary according to the lender’s applicable interest rate. The borrower will pay the prevailing interest rates applicable on the Business Loan.
The change in Business Loan interest rate directly impacts the EMI, which will keep changing during the loan tenure. Due to external factors or internal factors, if the lender’s base interest rate goes down, the Business Loan interest rate will reduce, and vice versa. Changes in the RBI policy, any new monetary policy, inflation and other such reasons are the main reasons for interest rates to fluctuate.
Fixed Business Loan interest rate
As the name suggests, this loan type has a fixed rate of interest throughout the tenure of the loan resulting in the exact EMI amount for the repayment tenure. A fixed-rate gives more security and assurance to the borrower as they know what they need to pay and will not be impacted by market fluctuations.
How does the Business Loan interest rate affect your EMI?
A lower interest rate translates into a lower EMI amount helping you save money on your monthly payments. The main consequence of a higher Business Loan interest rate on the EMI is that the borrower will have to pay more each month to repay the Business Loan.
A reduced Business Loan interest rate can even bring down your Business Loan tenure. This is because you had probably anticipated more monthly instalments, but with reduced outflow, you can prepay the entire amount or opt for foreclosure.
Here is an example to understand how Business Loan interest rates affect your EMI
Please find below an explanation for the two cases to highlight the difference in the Business Loan interest rate changes against the total amount being paid to the lender.
Mrs X takes a Business Loan of ₹50 lacs for 20 years. The lender offers her an interest rate of 8.5%. Assuming the principal amount and interest accumulated, the amount that will be needed to pay over the entire tenure of the loan will be ₹1,35,00,000.
(The calculation follows: The principal amount is ₹50,00,000, and the interest rate for 20 years at 8.5% per annum amounts to ₹54,13,880 (54 lacs). The total amount that Mrs X will end up paying to the lender will be ₹1,04,13,880 (1.04 crore).
However, if Mrs X were offered the same loan of ₹50,00,000 for 20 years at just a difference of 0.5% per annum at a rate of 9%, the difference would be monumental. An increase in the Business Loan interest rate from 8.5% to 9% will lead to her repaying ₹1,40,00,000 over 20 years (The calculation is as follows – Principal amount is ₹50,00,000, the rate of interest for 20 years at 9% per annum amounts to ₹57,96,710 (58 lacs). The total amount that Mrs X will end up paying to the lender will be ₹1,07,96,710 (1.08 crore INR approximately).
This simple example is good enough to explain how even a tiny change in the Business Loan interest rate can affect the EMIs and increase or decrease the monthly outflow.