Home loan: Fixed vs floating rates

Investing in a financial product, whether it is a home loan, involves your hard earned money. So it is important that you take time off to look at various aspects before rushing in to something. While applying for a home loan, the prior thing that will bother you is whether to choose fixed interest rate or floating interest rate. Let us see which option is worth for you?

Fixed versus floating dilemma

Home loan consumers often find themselves in a dilemma when it comes to choosing between fixed and floating interest rates. With fixed interest rate loans, the interest rate and hence the EMI remains fixed, whereas in floating rate loans, the interest rate or the tenure may move up and down. Nobody can predict which way interest rates will move and hence it all boils down to personal choice, cash flows and appetite for risk when it comes to choosing between the two.

In most cases you will also be given the option to switch from fixed to floating rates and vice versa. However, you will be charged for every switch that you make during the tenure of your loan. If you believe in taking risks with the hope that you will benefit when interest rates fall, you can opt for floating interest rates or else you can happily settle for a fixed repayment schedule.

Pros and Cons of Fixed Interest Rates:      

Since home loans demands a long term commitment in comparison to other loans, a fixed interest rate convey a sense of certainty in terms of loan repayment. People who are good at budgeting can get a clear vision of their EMI liabilities if they select for a fixed-rate home loan.

The major drawback with fixed interest rates is that they are usually 1 – 2.5 percentage points higher 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 fixed for the entire tenure or only for a few years. This has to be cross-checked with the bank while taking the home loan.

Pros and Cons of Floating Interest Rates:

Floating interest rate varies with market conditions and interest rates are bounded to a base rate and a floating element thereof. So, if the base rate varies the floating interest rate also varies. Although floating interest rates are cheaper than fixed interest rates, but the nature of monthly installments is uneven. This makes it difficult to budget with floating interest rate home loans.

Market Behaviour:  

Recently, fixed rate loans have gained popularity in India. Many financial institutions and banks are now engaging applicants utilizing fixed interest rate schemes. ICICI Bank has initiated a scheme proposing home loans up to 10 years at a fixed rate of up to 10.25%, while Citibank offers a fixed rate of 10.1% till September 2015.

Experts agree on the fact floating interest rates are a better option if the economic scenario promises a fall in interest rates in the near future. For a short term loans opting for a fixed interest rate would be beneficial whereas floating interest rate is recommended for people taking a home loan for a long tenure at this given time.

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Source- Secondary