Fixed or Floating Interest Rate Which is Best for Your Home Loan
Buying a house is one of the most important financial decisions people make in life. While buying a home is a great way to ensure a secure future, other factors need to be considered while applying for home loans. How much is the tenure, what’s the rate of interest, how much down payment do you need, and what are the additional charges?
The rate of interest plays a major role when considering getting a home loan. But the most important and complex question remains: If the fixed rate of interest would be better or the floating rate? For borrowers, this decision is something that can make a huge difference when it comes to getting a home loan. While you can do a Google search and find out all about it, it can get overwhelming for you. It is essential to do thorough research and get your doubts cleared. Floating and fixed, both have their set of pros and cons. But, let’s start with what both of them mean.
Floating Interest Rate
A floating interest rate, as its name suggests, is a rate that keeps changing as per the market conditions. When the market rates increase, your rate of interest will also increase automatically.
There are two parts to floating interest rate – Spread and Index. While the Index is the interest rate that is set by the government or other central financial body, the Spread covers the additional charges that your bank or the lender charges for credit risk, profit markup, etc. The spread amount can vary from lender to lender, so you need to choose your lender very thoughtfully. When the index rate increases, your interest rate will also increase, resulting in higher EMIs.
When you select a floating interest rate on your home loan, you pay a base rate (which is usually low) as well as a floating component. The base rate is the minimum amount that is set by the lenders. You can’t get a home loan below the minimum base rate. An adjustable-rate means that the interest rate you pay depends on the rate environment in which you live. Therefore, as interest rates in the economy rise or fall, your monthly payment will rise or fall in accordance. Some banks also offer to make adjustments where your EMI remains constant but the tenure increases.
Why choose a floating interest rate on your home loan
You may get confused when it comes to choosing between floating and fixed as both have their pros and cons. Here are the factors that make the floating rate of interest great for your home loan.
Market conditions prediction:
If you can anticipate future interest rate reductions on home loans, you might want to consider a floating interest rate. A reduction in the interest rate can help you lower the cost of your loan.
You can save money month after month on your EMI with a lower percentage of interest. The floating rates offered by the same lender are typically 1% to 2.5% lower than the fixed rates
When you choose a floating rate of interest on your home loan, there are higher chances of savings and you enjoy some unexpected benefits. In the case where market interest rates are lower than the base rate, the rate of interest will be lower
While there are many benefits of a floating rate of interest, there are some disadvantages too which you need to be cautious about.
You can enjoy the benefits of a fluctuating rate of interest in terms of lesser EMIs, but it comes with its set of disadvantages. Fluctuating rate means that there are chances that the market rate will go up and you will end up paying more rate of interest. To avoid defaulting on the EMI, you should be able to predict the EMI and have that amount available in your bank account.
With the floating rate of interest on home loans, it gets difficult for people to plan their monthly budget. Especially for those who are used to planning a budget that lasts only till the end of the month. With no fixed EMIs, you won’t be able to plan your monthly expenses. There will be some months where the EMIs amount would be far above the one you are comfortable paying. This, in turn, will affect your monthly savings.
One can suffer some serious damage if the interest rate rises to a point where paying the EMI becomes difficult. Credit score records can be affected and the lender can list you as a defaulter, which will affect future loan applications.
Fixed-rate of interest on home loan
A fixed rate of interest is when the bank or the lender charges the same rate of interest throughout the tenure of your home loan. People generally prefer a fixed rate of interest for long-term loans since it is easy to plan and make a budget accordingly. In simple terms, the EMI remains constant for all months and remains unaffected when the market rate changes.
Why choose a fixed rate of interest
Fixed repayment amount
With a fixed rate of interest on a home loan, there are no speed bumps or shocks. You know from the beginning how much money has to be paid every month. Therefore, you will be able to plan things better.
Immunity from market fluctuations
With a fixed rate of interest, there is no need to worry about sudden fluctuation in the interest rates.
Since you would know the EMI amounts well in advance, you can plan your finances way better.
Now we come to some of the disadvantages that come with fixed-rate interest.
Potentially higher EMIs
In the event the interest rates are slashed, you will have to pay a higher rate of interest for your home loan. This means when the market condition changes and the interest rate goes low, you won’t be able to benefit from it. You will have to pay the rate that was fixed during the loan application process.
The fixed-rate is generally higher than the floating rate by 1-2.5%. The lenders account for the additional charges for the possibility of rising home loan rates.
Now the question is, which one you should choose. You should consider all the factors mentioned above and then see which kind of interest scheme you are more comfortable with.