When you start to make more money in life, you will be faced with the opportunity to own your home using a home loan. Getting a home loan is not a difficult task nowadays, but choosing between a fixed and floating interest rate can be difficult choice. It’s important that you consider both, weigh the pros and cons and then make an informed decision. If you are completely new to the field and have no idea what these terms mean, read on to get a basic idea :
What is Fixed Interest Rate?
If you choose fixed interest rate, it means that you will be repaying the home loan in fixed equal instalments throughout the loan term. The main highlight of this type of interest rate is that it is unaffected by market fluctuations. If you are very particular about budgeting and prefer to plan out your repayment schedule with a fixed monthly amount, this type of interest rate would interest you more as it gives a sense of certainty. The main disadvantage of fixed interest rate is that that they are usually 1-2.5 percentage points higher than the floating rate home loan. Another drawback is that in case the interest rate decreases, you will not be able to take advantage of the reduced rates and will have to continue paying the same amount. It is important that you check the fine print and see whether the fixed rate home loan is fixed for the entire tenure or only for a few years. If you see the economic scenario promising a rise in interest rates in the near future, fixed rates would be a better option
Benefits of Fixed Interest Rate
- As the name suggests, the fixed interest rate remains constant for the entire loan tenure. This rate of interest doesn’t vary according to the rise and fall in the market.
- Since this interest rate doesn’t fluctuate over time, you will have to pay a fixed monthly installment throughout the tenure. Therefore, you can easily and accurately plan your finances under this type of rate of interest.
- It is the best option for people who are good at budgeting and prefer a fixed EMI schedule.
- If the economic conditions indicate that there are chances of a rise in the interest rates in the future, this is the best option that a borrower should choose in order to ensure that he or she can continue to pay a smaller amount as interest.
Drawbacks of Fixed Interest Rate
- The fixed interest rate is usually 1% to 2.5% higher than the floating interest rate offered by a bank or non-banking financing company (NBFC).
- Even if the fixed interest rate reduces after an announcement from the Government or Reserve Bank of India (RBI), it doesn’t affect the loans already borrowed using the previous interest rate. The borrower will have to continue repayment at the higher interest rate even after a rate cut.
- Many a times, the fixed rate of interest is only valid for a couple of years. In that case, once this period is over, the interest rate will get revised according to the ongoing rate. This might not be a beneficial plan in the long run.
Why choose a Fixed Interest Rate?
See the reasons you should go for this interest rate option mentioned below:
- You prefer a fixed repayment schedule and are comfortable paying the current interest amount. You should ensure that your monthly installment isn’t more than 30% of your net monthly salary.
- You foresee a rise in the interest rate in the future and, therefore, want to ensure that your interest amount doesn’t increase more than what you are currently paying. In such a scenario, the fixed interest rate can be used to lock in the current rate of interest being offered by the lending organisation.
- In case there has been a recent decline in the interest rates and you are comfortable repaying your loan at this rate, you can opt for a fixed rate of interest while borrowing a loan.
What is Floating Interest Rate?
As the name suggests, floating interest rate varies with the market scenario. If you opt for a home loan with a floating interest rate, it means that you will be subjected to a base rate and a floating element will be added. This means that if the base rate changes, the floating rate will also vary. The main highlight of floating interest rate is that they are cheaper than fixed interest rate. For example, if the fixed interest rate is 14% and floating interest rate is 11.5%, you will still be saving money even if the floating interest rate rises by 2.5% points. Further, even if the floating interest rate rises above the fixed rate, it will be temporary, and not for the entire tenure of the loan. The main drawback of floating interest rate is the fact that it is difficult to budget as it may change frequently. Planning your financials on a long term basis can be difficult with this type of interest rate.
Benefits of Floating Interest Rate
- The floating interest rates offered by a bank or non-banking financing company is usually lower than the fixed rates it offers its customers. Therefore, it means that even if the floating interest rate increases, it can still be less than the previous fixed interest rate offered.
- In case the floating interest rate exceeds the interest rate, it will not be for the entire loan tenure. There are chances that the floating rates might come down after a certain period of time.
Drawbacks of Floating Interest Rate
- Due to the fluctuating nature of floating interest rates, the monthly installments of a particular amount of loan will vary throughout the entire loan tenure.
- Attributed to the uneven monthly installments, it is very difficult to budget a loan with floating rate of interests.
- Since it is not possible to have a fixed repayment schedule under this interest rate option, it can lead you to pay more than you are comfortable paying. This can, therefore, cause you to have less savings and no budget plan.
Why choose a Floating Interest Rate?
- You can go for a floating interest rate for your loan when you apprehend that the rates might decrease in the future, thereby, reducing the total cost of the loan.
- If you are looking to save a little in as floating rates are usually set 1% to 2.5% lower than the fixed interest rate offered by the same lending organisation
- This type of interest rate usually suits people who do not possess enough insight regarding the market and, thus, want to stick to the market rates.
In conclusion, choosing the type of interest rate that you should go for is a personal choice. What works for one individual may not necessarily be the best choice for you. If you prefer to plan well ahead when it comes to your finances and not leave anything to chance, a fixed rate would be better suited to your needs. This, however, comes with a higher price. Before you make a decision, you must consider home loans with fixed and floating rates from different institutions. Go through the fine print and ensure that you choose one that you are most comfortable with.