Getting a home loan is very easy nowadays. However, choosing the best option is always a complex aspect. One should do proper homework before rushing in to something. While applying for a home loan, the first thing that will bother the applicants is whether to go for fixed interest rate or floating interest rate. Let us see which option is better.
Fixed interest rate
Fixed interest rate means repayment of home loans in fixed equal installments over the entire period of the loan. In this case, the interest rate doesn't change with market fluctuations. During the early part of the loan tenure the majority of monthly payments are used to service the interest and the principal is served in the later parts of the tenure.
- Interest rate remains fixed irrespective of market conditions
- A fixed-rate home loan is excellent for those who are good at budgeting and want a fixed monthly repayment schedule, which is easy to budget and doesn't fluctuate
- It brings a sense of certainty and security
- The major drawback with fixed interest rates is that they are usually 1-2.5 percentage points higher than the floating rate home loan. Secondly, if for any reason the interest rate decreases, the fixed rate home loan doesn't get the benefit of reduced rates and the borrower has to repay the same amount every time. Another area of concern is whether the fixed rate home loan is fixed for the entire tenure or only for a few years. This has to be cross-checked with the bank while taking the home loan. A fixed home loan, which can be changed every few years, will definitely wipe out the very spirit of such a loan. Experts agree on the fact fixed rates are a better option if the economic scenario promises a rise in interest rates in the near future.
Floating interest rate
Floating interest rate by name implies that the rate of interest varies with market conditions. Home loans on floating interest rates are tied to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies.
- The biggest benefit with floating rate home loans is that they are cheaper than fixed interest rates. So, if you are getting a floating interest rate of 11.5 per cent while the fixed loan is being offered at 14 per cent, you still save money if the floating interest rate rises by up to 2.5 percentage points.
- Even if the floating rate goes over the fixed rate, it will be for some period of the loan and not the entire tenure. The interest rates will surely fall over a long period and, thus, the floating interest rate brings a lot of savings.
The drawback with floating interest rates is the uneven nature of monthly installments. This makes it difficult to budget with floating interest rate home loans. As seen in recent times, due to the hike in floating home loan interest rates, the borrowers had to shell out thousands per month extra as their EMIs, throwing their entire budget out of order.
Let us understand it with an example. Suppose you have taken a loan of Rs 25 Lakh for 20 years.
- Floating interest rate is 9.75 per cent
- Fixed interest rate is 10.5 per cent
If you go with the floating interest rate then the EMI will come to around Rs 23,712, whereas the EMI under fixed interest rate option will be Rs 26,660. So, if you choose floating rate, you end up saving around Rs 2,948 every month. Though this amount looks small, it will make a big difference in the long term.
However, you will benefit by choosing a floating rate home loan only as long as the interest rate does not go beyond 11.5 per cent.
When it comes to choosing the interest rate, a majority of home loan borrowers go for floating rates.
Finally, it is up to the borrower to decide what suits him best. Before taking a decision, it is advisable for the borrower to compare home loans from different institutions in detail, including the various parameters set forth. If certainty and security are prime considerations, a fixed rate home loan will be the best. However, it won't come without the premium on interest rates.
InvestmentYogi.com is a leading personal finance portal.
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