Home loans offered at fixed rate of interest ensures that the borrower only has to pay fixed equal installments as home loan repayment, during the entire loan tenure. Market fluctuations do not affect fixed rate home loans, i.e., the interest rate remains the same no matter what the market conditions are. Most of the time, monthly payments made during the initial stages of home loan repayment is used to pay out the interest and when payments are made in the later stages of the monthly repayment of the loan, the principal is serviced.
Fixed rate home loans have fixed interest rates during the entire tenure of loan and this rate is not privy to change no matter what happens. Floating home loan interest rates change with changes in market conditions. Home loans that are offered on floating interest are attached to a base rate as well as a floating element therein. Hence, with a variation in base rate, the floating interest rate varies as well. One of the highlights of a floating rate home loan is that it is cheaper than fixed interest rates. In a fixed rate loan wherein the interest rate is stable, the interest rate is higher than that of the floating rate home loan.
In India, floating rate loans are not really varying consistently. RBI has instructed banks to bring down rates for all customers. However, bank lower prevailing interest rates for new customers and changes them later on with changes in the financial market. Older customers continue paying the interest rate set for them during the initial stages and do not enjoy the privilege of the lower interest rate extended to new customers. When interest rates come down, the EMI in a floating rate home loan is often kept stagnant and only the tenure of the loan is altered. Fixed rate loans are also have terms and conditions reset clauses and riders which can affect the interest rate when there are market fluctuations. The 'reset clause', which is subject to revision. Though the nature of the clause depends on the Bank’s regulations after a fixed period or with a sharp hike in interest rates the interest rates can be revoked.
Most banks announced their Marginal Cost of Funds-Based Lending Rate (MCLR) in April 2016. This rate is applicable only for floating rate-based loans. The banks are free to choose any MCLR of 1 year or below as benchmark for the home loans. The interest rate of home loans will be automatically reset every year based on this chosen MCLR.
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