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Buying a home is a major financial decision that most people
will make. Being a very big investment, most people cannot pay the full cost of
a home in a single payment. This is where a home loan comes in, it gives the
buyer the ability to buy their dream home for which the borrower will repay the
loan and interest in Equated Monthly Installments. It is when choosing the
interest rate that the dilemma comes in – to choose fixed rate or floating
rates.
Consider this example, Rupesh and Shital have booked their
dream apartment in a location they like. They planned on taking a home loan to
buy the apartment and applied for it at one of the top banks in India. The bank
accepted their application and they got through the verification process easily
as both had a good credit history.
Seeing this the bank offered them a loan offer with a fixed
interest of 10.20% and a tenure of 15 years. This is when they come to know
that the floating rate in the same bank is 9.35% due to which they their EMI
each month will reduce by at least Rs.5000. They were confused on which to
choose and decided to do some research before making the decision.
Many would be faced with the same dilemma, so here is a
short explainer.
Fixed interest rate
As the name suggests fixed interest rate is where you will
have a fixed rate of interest which means their EMI each month will be constant
throughout the loan tenure. If Rupesh and Shital are people who like to work
with a fixed budget each month then fixed rate of interest is their best
option. In case of any macroeconomic
problem their interest each month will not change which is a boon if the
interest rates rise.
The disadvantage with fixed interest rates are that if there
is any drop in the interest rate after the loan has been taken the borrower
cannot change their interest rate. Also, the interest rate for fixed interest
is 1-2% higher than the floating interest rate.
Floating interest
rate
The floating interest rate is where the interest rate will
vary based on the market conditions. It is beneficial when the rate of interest
decreases as the economy is doing well but Rupesh and Shital might have to pay
more if the is an economic down trend and the interest rates rise. Another
disadvantage with floating rate of interest is that there might be some issues
while planning the budget each month.
Which type of
interest rate to choose?
It depends on the what Rupesh and Shital are looking for. If
they follow the market regularly and feel that they have the lowest interest
rate possible and don’t see the rate of interest reducing any further, then they
can opt for fixed rate of interest to lock the interest rate.
On the other hand, if they if they believe they can manage
their finances and think that the interest rate will reduce even further then
they can opt for floating rates preparing their budget each month based on the
market. One can also change between fixed rate to floating rate or vice versa
by paying a nominal fee. Make sure you make the right decision after carefully
analyzing your financial capability and acumen, we hope our explanation would
help you choose between the two.