Your home loan interest rate significantly affects your overall cost of borrowing. Even a slight variation in the interest rates can lead to a huge difference in your loan repayment amount. This is why, when you avail of a housing loan, you must choose an interest rate that is best for you.
There are two types of interest rates on a home loan – floating and fixed. When you avail of a housing loan, you are required to choose between the two, which could be confusing.
Here is a detailed guide to help you pick the right interest rate for you.
What Is the Floating Rate of Interest?
As the name suggests, the floating rate of interest changes throughout the loan tenure. Also called adjustable-rate home loans, it is tagged to a benchmark rate and is reset from time to time. Whenever the benchmark rate increases or decreases, there is a corresponding change in the floating interest rates.
Following are the advantages of floating rate of interest:
- Typically, a floating rate of interest is lower than a fixed interest rate. Even though it fluctuates based on the market rates, it usually does not exceed the fixed rate of interest.
- You need not pay any prepayment penalty on floating interest rate home loans. As per the RBI mandate, lenders cannot charge a fee if you prepay a floating interest rate loan.
However, due to constant fluctuations, it becomes tricky to make your budget when availing of floating interest rates. There is always a sense of unpredictability about the interest outgo, which can restrict your financial planning.
What Is a Fixed Rate of Interest?
The fixed rate of interest does not change during the tenure. It is usually not affected by fluctuation in market rates or socio-economic factors. You pay the same EMI amount every month.
The advantages of fixed interest rate home loans are –
- It is easier to plan your budget when you know the fixed amount of interest outgo.
- With a fixed rate of interest, you get financial security. Whether you face a dip in income or salary hike, you know the EMI amount every month and can plan accordingly.
Fixed interest rate home loans have some disadvantages too.
- Typically, the fixed rate of interest is 1-1.25% higher than the floating interest rate.
- You need to pay the prepayment charges, as there are no rules about waiver of prepayment charges for fixed interest home loans.
- In the long run, usually, lenders can convert the interest rate from fixed to floating in between the tenure. This can disturb your financial plan.
You must assess your need and financial stability while choosing your interest rate. If you wish to avail of a short-term loan, it is better to opt for a fixed interest rate. It is because, the market is usually volatile in the short term, and opting for a floating interest rate could make your loan expensive.
Also, it is best to opt for a fixed interest rate if you anticipate an increase in the interest rates soon. Similarly, if you can forecast a drop in market rates and have no set budget, opting for a floating interest rate would be best.