The most crucial concern atop the list is ‘Home Loan’ and that whether to opt for ‘Fixed or floating interest rate’ while taking a home loan.
Riddle: A fixed rate or a floating rate home loan?
Fixed Rate Home Loan:
The interest rate is fixed at the time of taking the loan, when one opts for a fixed rate Home Loan. Apart from a regular fixed rate product where the rate of interest is constant over the entire term of the loan, there are variants available which allow you to fix your interest rate for specific periods of 2, 3 or 10 years and is available with the right of reset by the lender at any given point of time.
Opting for a fixed rate home loan gives borrowers a sense of certainty since they know what their repayments will be right from the time of taking the loan, giving them the confidence to budget accordingly and plan their finances. So there is a reasonable measure of predictability to the loan tenure, EMI commitments and the total interest outflow.
Fixed rate loans are usually priced a tad higher than floating rate loans. In case the difference is quite huge, borrowers may be swayed towards a floating rate loan. But if they are almost equal or if the difference is negligible, then one may want to assess their situation and needs, to decide whether to opt for a fixed rate loan or a floating rate loan.
A fixed rate home loan proves to be the best choice in the following circumstances:
The borrower is comfortable with the EMI they are committing to pay. It should ideally not exceed 25-30% of their take-home monthly income.
If one perceives a situation of rising interest rates in the forthcoming times, and hence, would choose to lock in their home loan at the existing rate.
If interest rates have dropped significantly in recent times and one is comfortable with the existing level of interest rates, lock in at this rate with a fixed rate loan. Say, if home loan interest rate was at 9% a few years back and has now declined to say 8.5% and one is financially comfortable with this rate, they can avail a fixed rate loan.
FLOATING RATE HOME LOAN:
Floating Rate Home loans are also known as ‘Adjustable Rate Home Loan’, and are linked to the lender’s benchmark rate, which, in turn, moves in sync with the market interest rate. If there is a variation in the benchmark rate, the interest rate on the loan changes proportionately.
The interest rate on such loans is reset at definite intervals. It could be calendar periods like every quarter or half of a financial year or it could be unique to each borrower, depending upon the date of first disbursement of their home loan. Alternately, the reset could also be linked to your loan anniversary.
If there has been a variation in the market rates during the review period, your rates too would be reset higher or lower as the case may be. In cases of such rate resets, it is usually the tenure of the loan that gets re-adjusted to account for the altered interest rate.
If the rate increases, the remaining loan tenure would be extended and vice-versa. This is done in order to evade frequent revisions to one’s EMIs which could significantly affect their cash flow. But if one desires, they may request the lender to revise their EMI instead of the loan tenure
A fixed rate home loan proves to be the best choice in the following circumstances:
If the borrower is expecting interest rates in general to fall over a certain period of time, opting for a floating rate loan in such picture will result in the interest rate applicable to their loan dropping too, subsequently reducing the cost of their home loan.
Floating rate loans are a great option for those who are uncertain about interest rate fluctuations and would choose to go with the market rates.
Also, if one is looking for some savings on their interest cost in the proximate term, floating rate loans are usually set at a marginally lower rate than fixed rate loans, thus offering them some benefit in terms of cost of their home loan.
Floating rate loans are popular due to the flexibility they offer to the borrowers.
If one is definite about interest rates rising in the future and would like to lock in their loan at the current rate, they need to opt for a fixed rate loan.
Anytime during the tenure of loan, one can convert their fixed rate loans into floating rate loans and vice versa, by paying a nominal fee.
There are no prepayment penalties in a floating rate loan.
One’s choice of fixed, floating or combination loan depends on one’s financial condition, needs and level of understanding of interest rate movements.
Fixed Versus Floating Interest Rate:
| Fixed Rate Home Loan | Floating Rate Home Loan |
| Fixed Interest Rate throughout the loan tenure | Interest rate varies based on the change in the lender’s benchmark rate |
| Rates are slightly higher | Rates are slightly lower |
| Pre-payment penalty | No pre-payment penalty |
If one is comfortable with the prevailing interest rates and are reasonably sure that interest rates will escalate in future, they are advised to opt for a fixed rate home loan.
If they are unsure about where interest rates are heading, they are suggested to opt for a floating rate home loan.
ABSTRACT:
Choose Floating Rate Home Loan in case when a borrower-
- Expects interest rates to fall
- Is unsure about interest rate movements
- Wants some savings on interest cost in the near term
Choose Fixed Rate Home Loan in case when a borrower-
- Is at ease with the EMI they are binding to pay
- Expects interest rates to upsurge
- Knows that interest rates have dropped and wish to lock in at that rate
- Is unable to decide between the available options
Important:
Borrowers can choose to switch between a fixed and a floating rate at a nominal fee.