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, there are factors that need to be considered when applying for a home loan. How long is the tenure? What is the rate of interest? How much down payment do you need? What are the additional charges?
The rate of interest tends to be a driving factor when weighing up a home loan. Deciding between a fixed rate and a floating rate is a frequently asked question. For borrowers, this decision is something that can make a huge difference. Both types of rates have their pros and cons. First, let’s start with what both of them mean.
Floating Interest Rate Home Loans
A floating interest rate, also known as an adjustable rate, is a rate that changes as per the market conditions. Therefore, as interest rates in the economy rise or fall, your EMI will accordingly rise or fall.
These resets aren’t random. They happen at defined intervals. It may be according to the financial calendar (every quarter or halfway through the year) or it may be determined by your loan anniversary.
There are two parts to floating interest rate: Spread and Index. The Index is the home loan interest rates set by market conditions by. The Spread covers the additional charges levied by your lender for credit risk, profit markup, etc. The spread amount can vary from lender to lender, so you need to carefully assess your options.
When you select a floating rate, you pay a base rate (which is usually low) as well as the spread component, a floating component. You can’t get a home loan below the minimum base rate.
Why choose a floating interest rate?
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 is a higher chance of savings along with some unexpected benefits. In the event where market interest rates are lower than the base rate, the rate of interest will be lower.
Disadvantages of Floating Rate Home Loans
An adjustable rate means that there is a chance that the market rate will go up and you will end up paying higher interest on your home loan. To avoid defaulting on the EMI, you should be able to predict the EMI and have that amount available in your bank account. Some lenders also offer adjustments in which your EMI remains constant but the tenure increases.
Budgeting – unable to understand this point
Budgeting becomes more important, especially for those who are used to planning a budget that lasts only till the end of the month. With no fixed EMIs, you may have to plan for at least three months, keeping aside enough savings in case the rate goes up. There could be some months during which the EMIs are far more than what you can comfortably pay. This, in turn, will affect your monthly savings.
Uncertainty – unable to understand this point
If the interest rate rises to a point where paying EMI becomes difficult. Credit score records can be affected and your lender could list you as a defaulter, affecting any future loan applications.
Fixed Rate Home Loans
A fixed rate of interest is when the lender charges the same rate of interest throughout the tenure of your home loan. In other words, the EMI remains constant for every month and isn’t affected by any changes in the market rate.
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 fluctuations in interest rates.
Since you will know the EMI amounts well in advance, it is easier to plan your finances.
Disadvantages of Fixed Rate Home Loans
Potentially higher EMIs – this is a negative point and shouldn’t be here. It is not a benefit.
In the event interest rates are slashed, you will be paying a higher rate of interest on your home loan. This means when the market conditions change 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.
High interest rates – this is a negative point and shouldn’t be here. It is not a benefit.
A fixed rate home loan is generally higher than a floating rate by 1-2.5%. Lenders account for the additional charges for the possibility of rising interest rates.
You should consider all the factors mentioned above and then see which kind of interest scheme you are more comfortable with.