Loan Tips: When taking out a loan, should you look for a low interest rate or a low interest spread? Find out here..

When we apply for any loan – whether it's a home loan, personal loan, or car loan – the first thing we look at is the interest rate. But banks don't just charge the advertised interest rate; there's a hidden factor behind it – the Interest Spread.

Many people don't understand the spread and simply take out a loan based on the low interest rate, only to find later that their EMIs are increasing and the loan has become expensive. So, the big question is: should you only look at the low interest rate when taking out a loan, or should you also understand the Interest Spread before making a decision? Find out here:

What do Interest Rate and Interest Spread mean in a loan?

1. Interest Rate - The rate that is visible first

This is the interest rate that banks display in advertisements, websites, or brochures. For example: 8.50%, 9.25%, etc. But this isn't the whole story.

2. Interest Spread - The bank's real profit
The Interest Spread is the margin that the bank adds above the base rate/Repo Linked Rate. That is, Final Interest Rate = Benchmark Rate + Spread. Your spread depends on your credit score, income, risk profile, and the bank's policy. Lower Spread = Cheaper EMIs in the long run.

Low Interest Rate Vs Low Spread
1. A low interest rate is not always beneficial
Many banks show a low interest rate in the initial months, but keep the spread high, which causes the EMI to increase rapidly when the Repo Rate changes.

2. Low Spread = Long-term Savings
If the spread is very low, the EMI doesn't increase as rapidly even if the Repo Rate rises. Therefore, loans with a low spread are more stable and cheaper.

Which choice is smarter?
Smart Decision: Prioritize a Low Spread. The reasons are:

EMIs don't fluctuate much even when the Repo Rate changes.
Savings of thousands or even lakhs in the long run.
Banks cannot suddenly increase interest rates.
But don't ignore the Interest Rate either.

What is the right approach? First, check the Spread, then compare the overall Interest Rate.

How to find out how much spread the bank is charging? The complete breakdown of RLLR/EBLR + Spread is mentioned on the bank's website.
The Spread is also mentioned in the loan agreement.
Always ask the bank, "For how many years will the Spread remain fixed?"

Let's understand with an example:
Bank A
Repo Linked Rate: 5.25%
Spread: 2.50%
Final Rate: 7.75%

Bank B
Repo Linked Rate: 5.25%
Spread: 1.75%
Final Rate: 7.00%
When the Repo Rate changes, the EMI for Bank B will increase less; therefore, Bank B is better.

Disclaimer: This content has been sourced and edited from Zee Business. While we have made modifications for clarity and presentation, the original content belongs to its respective authors and website. We do not claim ownership of the content.