Fixed interest rate or Floating interest rate: Which is better?

Updated on November 30, 20184 mins read
fixed and floating interest rate

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.

 

In comparison…

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 🙂


Tarini

Tarini

Tarini comes with a degree in Mass Communication and Media studies. She joined SwitchME as a content writer and moved on to being an assistant product manager. Tarini is an experienced Content Strategist with a background in Product development and management. She is skilled in SEO, social media strategy and online content marketing and likes to travel when possible
4 COMMENTS

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  1. Bala
    Jun 22 2015 at 11:56 am
    Reply

    Hi
    I have taken home loan from LIC HFL 2 years back. Amount 40Lakhs and fixed for 10 years for 10.95%.
    I increased my EMI from 39k to 59k per month and done partial payments.
    I brought my principle to 18Lakhs and I am planning to close it in 2 years of time from now.
    I would like to know as interest rate has come down. Is it right time to change my home loan considering I am going to close it in 2 years max. Ofcourse I need to pay 2% closing charge as I opted fixed for 10 years. Incase If I am not closing to keep some amount for tax purpose for few more years what should I do.
    Please help me deciding.
    Thanks and regards
    Bala.

    • Tarini
      Tarini
      Aug 05 2015 at 3:15 pm

      Hey Bala

      Since the interest rates have reduced, it does seem lucrative to switch your home loan. But before doing so, I would advise you to do a cost benefit analysis of how much will you save in the next 2 years Vs. the cost incurred. I’d suggest you to go ahead only if there is a significant difference. Further, it’ll be best if you close your loan as soon as possible as this way you will save more in the long run, this will help maintain a good credit score too.
      I hope this helps 🙂 you can use our balance transfer calculator to explore other options to switch to.

  2. Amit Solanki
    Nov 25 2014 at 11:52 am
    Reply

    I have take home loan from bank with two borrowers (husband & wife) but in registration property owner is my wife. Can I get the tax benefit on this property?

    • Chintan Udani
      Nov 25 2014 at 2:59 pm

      Hi Amit,

      If you are the one paying EMI on the home loan then yes you can avail tax benefit.