The most important detriment of loan is its affordability and the interest rate at which the loan can be availed by the borrower. The decision to apply for a home loan is an important decision and so is the affordable rate at which loans should be taken.  There are two options for the interest rate at which a person can avail of a home loan. They include a fixed interest rate and a floating interest rate.

Both options have certain pros and cons attached to them. The decision regarding the option of the interest rate is vital as it can impact your financial abilities, thus you should know necessary details concerning both the options and on what grounds they differ before arriving at a decision.

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What is a Fixed Interest Rate?

Assetscan-fixed interest rateFixed home interest rates are those rates that are completely independent of the market and do not fluctuate with the change in the market conditions. The borrower has to pay fixed interest on equal intervals throughout the tenure of the loan. This is a common option availed by people in an economy wherein the interest rates are expected to increase. However on the contrary the fixed rates can also prove disadvantageous if the interest rates fell in the future.

Fixed interest rates permit you to predict your EMI and also helps you to plan your repayment of the home loan with great ease. Another major disadvantage of availing loans using this interest option is that the lenders tend to charge higher rates in comparison to the floating interest rate. A person may opt for fixed interest rates in various conditions such as:

  • The interest rates on the home loan have fallen and you want to make the most out of it, then it is better to take the loan at a fixed rate of interest.
  • In cases you are uncomfortable and worried that the interest rates may raise, then you may opt for fixed interest rate home loans. This option will give you more stability and the ability to plan your repayment.
  • After you calculate you’re EMI and if it dips into more than 25-30% of your income, then you should not hesitate to avail of this option while taking the loan.

What is the Floating Interest Rate?

Assetscan- floating interest rateThe floating interest rates are those rates that fluctuate over the tenure of the loan. You will be unable to foresee the EMI in this case and also won’t be able to plan your repayment with the most certainty.  The main advantage of opting for a floating interest rate is that when the interest rate falls due to the intervention of external factors such as repo rate, your home loan will be benefited from the same.

On the other hand, if the interest of the loan raises due to external factors, then your loan will also suffer. However, in cases wherein the interests keep increasing, the borrower can ask the lender to extend the tenor of the loan so availed.

The tenor of the loan is usually long in under this option and usually evens out the increase in the interest rate. It is better to avail floating interest rates when you can prepay your loan through the surplus as under this option there are no prepayment charges, unlike the fixed-rate loans in which you will be required to pay a penalty of 2.5-3 percent on the outstanding principal amount.

Different types of floating interest rate funds

The Floating Interest Rate funds which are commonly available are short term or long term funds. The Short term floating interest rate funds refer to the lean more towards short-term maturities offering which provides greater liquidity while on the other hand long-term floating interest rate funds refer to the lean more towards long-term maturities that are not aggressive but placed on a similar basis to the short-term funds.

Fixed interest rate v/s. Floating interest rates

The decision to decide on which type of home loan to choose may vary according to your financial conditions and outlook. If you are not sure as to which option to avail of, most of the banks providing home loans have a combination of the two called a time-bound fixed interest rate. According to this option, you can avail of the loan at a fixed rate for 3-5 years after which it can be availed at floating interest rates, thus allowing you to get benefits of both. There are also some banks that help in changing the option at a nominal fee.

The various differentiations that could be made on the fixed-rate and floating interest rates are listed in the box below:

Parameter Fixed-Rate Of InterestFloating Rate Of Interest
Interest rates The interest rates are generally high and are fixed. The interest rates are comparatively lower and are not fixed.
External factors The financial market conditions and external factors such as repo rates do not affect the fixed interest rate.The financial market and external factors do affect the interest rate and in times when the interest rates increase your loan will suffer. However it is beneficial if the rate goes down.
Planning budgetThe EMI payable can be predicted and thus helps you to plan your budget.Since there are chances of fluctuation in the rate of interest payable, it will be difficult to plan your budget.
Security The fixed interest rates provide its users with a sense of security. It may not be the same for people that availed floating interest rates. However, you can generate savings.
Suitability The option is suitable for those availing loans for a short or medium-term loan (3-10 years). It may also be suitable if your economy is such that there are chances that the interest rates may rise rapidly. This is a method that is suited best for loan term loans (20-30 years).
Prepayment The lenders generally charge you in cases of prepayment of your loan by 2.5-3% of your outstanding principal amount. This is not the case with the float interest rates.
Risk The lesser risk associated with fixed interest rates. Higher is the risk involved in floating interest rates.

Conclusion

Investing in a house involves a series of various decisions that has the power to impact your life for a considerable amount of time. So are the decisions that you take regarding the financing of your investment. Thus it requires careful calculations and evaluations before arriving at a decision. As explained above, fixed interest rates are those that are fixed and no external factors and market conditions can affect it. On the other hand, floating charges are those that fluctuate with the change in the financial market.

Thus summing up, it can be stated that you may opt for a floating interest rate if you expect the interest to fall soon or if you want some savings in your interest cost in the near term. If you are comfortable with a calculated EMI or if you are afraid of the rise in the interest rate, then it is recommended that you opt for a floating interest rate. In cases of uncertainty, you may apply for the combination or even switch by paying the nominal value demanded by the bank.