Home Loan: Fixed vs Floating Interest Rates

Homebuyers may find the process of financing a property to be tedious and lengthy. To make the best decision, you must have a solid understanding of the various types of interest rate regimes. Purchasing a home necessitates a number of decisions that can have a long-term, even decades-long, impact on your life. After you’ve decided to ‘purchase,’ the next step is to choose the ideal home for you and your family. Then there’s the decision of whether to get a home loan with a fixed or floating interest rate. Because this decision has a financial impact, it must be carefully considered. Here are a few ideas to assist you in making the best decision possible. 

Fixed rate home loan

The interest rate on a fixed rate loan is set when the loan is taken out. Aside from a traditional fixed rate product, where the interest rate remains constant during the loan term, there are versions that allow you to lock in your interest rate for particular periods of 2, 3, or 10 years, with the lender’s right to adjust the rate at any time. 
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A fixed rate home loan gives you peace of mind since you know what your monthly payments will be right from the start, giving you the confidence to budget and manage your money effectively. As a result, your loan tenure, EMI commitments, and total interest outflow are all reasonably predictable.

Pros

Remains constant throughout the tenure

The key advantage of fixed-interest financing is that your rate will not change even if market prices fluctuate, as they will when the Reserve Bank of India alters the rate at which banks can borrow and lend.

Helps you plan your budget

Borrowers can lock in their interest rate and manage their other finances in a fixed-interest rate situation. If you choose this interest rate, you’ll know exactly how much each monthly payment will be during the term of the loan.

Easy to understand

Fixed-rate mortgages are simple to comprehend and vary little from one lender to the next. They are an excellent option for individuals who meticulously prepare their budgets, as this rate demands you to pay the same number of monthly installments (EMIs) year after year for the duration of the loan. The EMI is calculated using a home loan EMI calculator.

Cons

Is costlier

Fixed interest rates are typically 1.5 percent to 2 percent higher than floating interest rates because the rate remains consistent during the term and banks are unable to change them. Despite the steadiness in installment payments that it may provide, this could make your overall loan more expensive.

Offer lower chances of paying less when rates are fall

Even if the market interest rate falls, people who have chosen a fixed-rate interest rate regime would see no change in their EMIs and will not be able to profit from the rate drop.

Is tough to get when the rates are high

When home loan interest rates are high, applying for a loan becomes more challenging due to the increased payments required.

In the following situations, you should choose a fixed rate house loan:

• You are satisfied with the EMI you have agreed to pay. It should preferably not exceed 25-30% of your monthly take-home income.
• You believe that interest rates will rise in the future and would like to lock in your house loan at the current rate.
• If interest rates have recently fallen and you are satisfied with the present level, a fixed rate loan will allow you to lock in the current rate.

Floating rate home loan

These loans, often known as ‘adjustable rate home loans,’ are linked to the lender’s benchmark rate, which moves in lockstep with the market rate. The interest rate on the loan changes proportionately when the benchmark rate changes.

Depending on the terms and conditions of your loan, floating interest rates are modified on a regular basis. It could be done every quarter, half-year, or year.

Pros

Linked to the repo rate

The repo rate, or the rate at which banks borrow from the Reserve Bank of India, is directly tied to these interest rates (RBI). Housing loans with floating rates are more cost-effective in the long run than home loans with fixed rates.

Applies base pay interest

You must pay a base pay interest if you pick variable interest rates for your home loan. The base rate is merely the lender’s minimum interest rate, so when it changes, the floating rate changes as well. The Reserve Bank of India (RBI) determines this based on a number of economic factors.

Can fluctuate

The great dependence of floating interest rates on market trends causes them to vary in the near term. However, it is less expensive than a fixed interest rate.

Even if the interest rate rises by 1-2 percent or more when a floating interest regime is chosen, the borrower saves more because as interest rates rise, the floating interest rate is often modified such that instead of the monthly installment going higher, the loan’s tenure is prolonged.

When market rates fall, floating rates are changed to reduce the loan’s duration rather than the monthly payment.

Impose no prepayment penalty

There is no prepayment penalty with floating interest rates. In the case of floating interest rates, the RBI has prohibited any form of prepayment penalty imposed on any transfer to a lower rate. Fixed interest rates, on the other hand, do not offer this benefit because the prepayment penalty applies if the loan is paid off before the scheduled repayment period.

Cons

Unpredictable

Floating interest rates are entirely uncertain, making budgeting difficult for borrowers. As a result, if you desire certainty and consistency in your EMIs, this option might not be for you because the interest rate fluctuates a lot.

Can be inconvenient

There are times when the interest rate rises to the point where the borrowers’ EMI payments become slightly inconvenient. This is due to their dependence on market conditions.

Makes planning finance difficult

If the interest rate on loan changes, the EMIs may alter as well. This can make your monthly financial planning and experience more uncertain. You can also only save if the floating interest rate does not stay above 11.5 percent for an extended period of time.

• In the following situations, you should choose a floating rate house loan:
• If you expect interest rates to decrease in general, choosing a floating rate loan will result in the interest rate applicable to your loan falling as well, lowering your loan’s cost.
• Floating rate loans are good for people who aren’t sure how interest rates will change and would rather stick to market rates.
• If you’re looking for a quick way to save money on interest, floating-rate loans are typically set at a slightly lower rate than fixed-rate loans, offering you a financial advantage.