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Fixed V/s Floating Interest Rates on Home Loans: Which is a better option?

 

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Getting a home loan is very easy now a days, however choosing the best option is always a complex aspect. One should do a proper homework before rushing in to something. While applying for a home loan, the first thing which will bother the applicants is whether to go for Fixed Interest rate or Floating Interest rates?

Let us see which option is better.

Fixed Interest Rate on Home Loan

Fixed Interest Rate means repayment of home loans in Fixed Equal Installments over the entire period of loan. In this case the interest rate doesn’t change with Market fluctuations. During the early part of loan tenure the majority of monthly payments are used to service the interest and principal is served in the later parts of loan tenure.

Benefits of Fixed Rate home loan

  • 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.

Drawbacks of Fixed Rate home loan

The major drawback with fixed rate is that it is usually 1 - 2.5% more 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 'truly fixed' or fixed for just few years. This has to be ascertained 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 the fixed rate are a better option if the economic scenario promises a rise in interest rates in near future.

Floating Interest Rate on Home Loan

Floating rate by the name implies that the rate of interest varies with the market conditions. Floating interest rate home loans are tied up to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies.

Benefits of Floating Interest rate on Home loan

  • The biggest benefit with floating rate home loans is that they are at least 1%-2% cheaper than fixed interest rates. So, if you are getting a floating interest rate of 11.5% while, the fixed loan is being offered at 14%, you still save money if the floating interest rate rises by up to 2.5%.
  • Even if the floating rate goes over the fixed rate, it will be for some period of the loan not for the entire tenure. The interest rates will surely fall over a long period and thus floating interest rate brings a lot of savings.

Drawbacks of Fixed Rate home loan

The drawback with floating interest rate 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 EMI's, 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%.
  • Fixed Interest rate is 10.5%.

If you go with the floating interest rate then the EMI will come to around Rs. 23,712, whereas the EMI under the Fixed Interest rate option will be Rs. 26,660. So, monthly you end up saving around Rs. 2948.Though this amount look small, it will make a big difference in the Long Term. However, you will benefit choosing a floating rate home loan as long as the interests do not go beyond 11.5%.

Conclusion

When it comes choosing the interest rate, majority of home loan borrowers, in fact over 90% of them go for a floating interest rate home loan. Finally, it is up to the borrower to decide on what suits him the 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.

Published Dec 15 2011

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