Fixed interest rate or Floating interest rate: Which is better?
Updated on November 30, 20184 mins read
Getting a home loan is very easy nowadays, what’s hard is making sure that you have right kind of interest rate on it. Any wrong decisions can lead to financial losses. When taking a home loan, choosing between fixed and floating interest rate is usually a tough decision for most borrowers.
Several of our customers face the dilemma of choosing the right kind of interest rate for their home loan, so we came up with a guide to help you make the right decision:
What is fixed interest rate?
A fixed interest rate on your home loan implies that the lending rate will remain fixed for the entire term of the loan or for a part of the entire term. Generally, fixed rates are 1% to 2.5% higher than the prevailing floating rates.Nowadays very few banks offer home loans at fixed interest rates, those who do so, offer fixed rates for a short period of the entire tenure. This makes borrowers susceptible to floating rates once the fixed tenure is over. So you must go through your loan agreement carefully before you go ahead.
What is floating interest rate?
A floating interest rate on your home loan implies that the lending rate will be subject to revision quarterly. Since the lending rate is tied to the base rate, revisions in base rate by RBI will directly impact your home loan’s interest rate. Generally floating rates are preferred by most borrowers.Though there can be regular ups and downs depending on the market dynamics, one big advantage floating rates offer is that you can switch your home loan to a lower interest rate anytime you like, due to the removal of prepayment penalty by the RBI.
1. Floating rates are cheaper than fixed interest rates: The biggest benefit with floating rate home loans is that they are always cheaper than fixed rates. Here is an example to help you understand it better;Suppose you have taken a home loan of 20 lakhs for 10 years
Floating interest rate offered is 10.15%
Fixed interest rate offered is 12%
If you go with the fixed rate, then your EMI comes up to Rs. 28,694. But if you go with the floating interest rate, then your EMI comes up to Rs. 26, 957. By choosing a floating interest rate you will be saving Rs. 2,097 every month. this looks like a small amount but if calculated over the entire tenure of 10 years, you stand to save Rs. 2,51,640! Since floating rates are subject to regular revisions, you will still save money even if the rate rises by 1.50%.
2. No pre-payment penalty on floating interest rates: Since the RBI has banned pre-payment penalty on all floating rate loan, you can switch to a lower interest rate any time you like. This is not possible with fixed rate loans as you will need to pay a heavy prepayment penalty to switch to a lower interest rate.So If your home loan is at a fixed rate of 12% and the prevailing market rate is 10.15%, then the pre-payment penalty will diminish the monetary benefits of switching. This means you will have no option but to continue paying the exorbitant 12% on your home loan.
3. Fixed interest rates allow you to your plan finances: Since home loans come with a longer tenure compared to most other loans, a fixed interest rate brings a sense of clarity when it comes to loan repayment. With a fixed interest rate you can get a clear idea of your EMI outgo over the entire tenure of home loan. However, one must opt for it only if the fixed rate being offered is not exorbitantly higher than the prevailing floating rates and can be revised every few years. This will help keep a check on the margin of difference between fixed and floating rates. You should go for a fixed interest rate if the current rates are low. and the difference between fixed and floating rates is minimal.
What should I choose in the current scenario?
Given the current market dynamics, opting for a floating interest rate on your home loan seems to be a better option. At present, 10.15% is the lowest floating interest rate being offered by several banks like SBI, ICICI Bank, LIC Housing Finanace, Axis Bank and HDFC Bank. For women borrowers, SBI has a special scheme of 10.10%.
Experts believe that interest rates are expected to fall in the future. Hence opting for a fixed interest rate is a good idea only for those who are taking short term loans for 5 to 10 years. ICICI Bank is offering home loans up to 10 years at a fixed rate of up to 10.25%. Citibank is offering a fixed interest rate of 10.10% till September 2015, while PNB Housing Finansce is offering fixed interest rate home loans at 10.75%.
Can I convert from a floating to fixed interest rate or vice- versa?
Yes, you can switch from a floating rate to a fixed interest rate, but the reverse would require you to pay a prepayment penalty. This adds substantially to the cost of switching from a fixed interest rate, making it disadvantageous in most cases.
Meanwhile, if your home loan is on a high interest rate, use our calculator to find a bank offering a lower rate and switch your loan! You can sign up and have us do the entire process for you so that you have a little extra time to enjoy life 🙂
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