interest rate

Home Loan Interest Rate: Pros and Cons of Fixed vs Floating Rates

Sunita has always been weak in finance. Generally, she looks forward to a discussion with her friend Moonmoon when she can clarify her concepts.

Sunita lives with her mother in a rented flat in Kolkata but of late, she planned to buy a flat in a gated community. Her mother is old and Sunita feels a gated community will provide a greater feeling of security. Sunita lost her father while in college and since then she is highly attached to her mother ‚ÄĒ a reason why she is delaying her marriage in spite of her mother‚Äôs intermittent speeches.

Sunita works as a research scientist on Chemical Biology in a government research organisation in Kolkata. After her office hours one day, she visited her friends Moonmoon and her husband Raj at their home to learn a thing or about home loans.

She was particularly interested to know about home loan interest rates, and how fixed rate and floating rate differ. What type should she opt for? Which will be more convenient and will have less interest outgo?

With a mug of coffee and some fritters, she sat down with Moonmoon and Raj.

Fixed-Rate of Interest on Home Loan                               

Fixed-rate of interest does not change during the lifetime of the loan. It is fixed at the start of the loan tenure and will remain constant.

A fixed-rate home loan in which the interest rate is pre-fixed for the tenure of the loan provides a known cash outflow for a known period. EMI and loan tenure remain the same irrespective of market situations and changes in repo rates, etc.

As per the prevalent risk management practices, banks/housing finance companies offer fixed interest rates for a maximum of 2 years and reset after that.

A fixed-rate home loan assists in long-term planning and budgeting by enabling a fixed monthly repayment schedule, which is easy to budget and doesn’t fluctuate. It ensures financial security since customers need not expect any future risks.

Floating Interest Rate on Home Loan                               

In the case of floating rate of interest, interest rate changes along with the market conditions.  If you choose the floating interest rate on your home loan, you will have to pay a base interest rate, while a floating element is added to the loan. The base rate is simply the minimum interest rate set by the lender or the benchmark of interest rates. Banks and NBFCs are not allowed to lend below the base rate. As such, when the base rate is changed, the floating rate also varies.

Lenders typically adjust the tenure of the loan and keep the EMI constant in floating-rate loans. If interest rates were to fall in the future, you will benefit from a reduction in your repayment tenure. If rates move up instead, your repayment tenure can increase.

Fixed vs Floating Rates: Pros and Cons

The greatest benefit of opting for the floating rate of interest is that the interest rate is typically lower than the fixed rate of interest offered by banks and NBFCs. As such, even if the floating rate of interest increases, borrowers have to pay a lower interest rate as compared to the fixed rate of interest. If the economy continues to remain stable, you end up saving a lot more money than if you choose a fixed interest rate.

You must remember that the main difference between floating and fixed interest rates is that the former is usually 1% Р2% points lower than the latter. Also, in case the rate of interest decreases in the market, you cannot take advantage of the decreased interest rate if you choose a fixed rate of interest. You must continue paying the same monthly instalment even if the rates are reduced in the market.

Since the rate of interest is floating, there is a chance that it can exceed the fixed interest rate. However, even such a situation is temporary. The interest rates can reduce after a certain point of time, whenever the economy returns to normalcy.

Choosing your fixed or floating interest rate on the home loan depends upon the market conditions. If you are confident that the prevailing rates of interest are reasonable and you believe that the rate of interest will increase in the future, it is better to opt for a home loan with a fixed interest rate. However, if you are skeptical or unsure about the market conditions and believe that the interest rates can fall in the future, it is better to opt for the floating interest rate.

Why not contact us for a detailed discussion on home loans and the best course of action for you?

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