When you decide to purchase a house of your preference, you decide to take a major financial step towards the acquisition of a valuable immovable asset. If you have decided to avail a home loan to finance this decision of yours, you need to make sure to do the best you can to reduce your financial outlay as much as possible. There are a number of factors to be considered when you have to select the best home loan or lending option available to you. And the most important factor to be considered is the interest rate.
Interest rates are the factors that influence the quantum of your monthly EMI the most. A decimal change in these rates can make a big change in the amount of EMI you remit towards the repayment of the home loan. Thus, you need to consider the rate of interest very carefully along with the tenure of the home loan and the loan amount you want to avail to finance your decision. This article seeks to share some valuable information about home loans and address important questions about the topic.
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Is home loan interest fixed or floating?
Home loan interest rates are of two types:
- Fixed Interest Rate
- Floating Interest Rate
You can select either a fixed interest rate lending option or floating interest rate lending option when you avail a home loan for financing your decision of purchasing a house.
- A fixed interest rate means that you have to repay your loan amount at a fixed interest rate during the period of the home loan. Your installments are fixed and equal in the amount due to your selection of a fixed interest rate.
- The majority of your installments made during the early part of your loan tenure are used to cover the interest of the loan amount. The installments you make in the later part of your loan tenure is used to cover the principal amount.
- A fixed interest rate is not adjusted according to the fluctuations in the market. It remains fixed irrespective of the market conditions.
- A floating interest rate, on the other hand, varies during the term of the loan as the market conditions change.
- Home loans with floating rates have a base rate with a floating element on it. If the base rate fluctuates, the floating rate also changes.
Which type of interest rate is better for a home loan?
Both fixed interest rates and floating interest rates have some benefits and drawbacks that you should be aware of and take into consideration when selecting which type of interest rate you want to avail.
The benefits of a fixed interest rate are the following:
- The fixed interest rate does remain fixed irrespective of market conditions. Thus, if you have availed a home loan at the fixed interest rate of 11%, you need not worry about the interest rate changing when market conditions fluctuate. There are times when market conditions fluctuate to cause interest rates to rise. However, fixed interest rates remain unchanged.
- Fixed interest rates are beneficial for you when you avail a home loan option with a long tenure. Market conditions are subject to change every now and then. If you were to avail a lending option with a floating rate for a long tenure, you would see the rates change several times over the loan tenure which may prove detrimental.
- If you have a budget and a schedule to follow when repaying the loan amount, a fixed interest rate is best because floating rates may cause confusion and upset your repayment schedule.
Drawbacks of fixed interest rate are the following:
- Fixed rates remain unchanged even when market conditions cause the overall interest rate to drop. Thus, you lose the benefit of dropping interest rates.
- Fixed interest rates home loans are usually given at higher percentage points than floating interest rate home loans to account for a drop in interest rates if any in the future.
The benefits of Floating interest are as following:
- You get the benefit of interest rate drops or cuts when the market conditions fluctuate to cause the prevailing interest rates to fall.
- Floating interest rates are beneficial for home loan options of short tenure.
- Floating interest rate home loans are usually given at lower rates than the fixed interest rate loans. Even if the floating rate goes higher than the fixed-rate during market fluctuation, it will not remain so due to its fluctuating nature.
Drawbacks of floating interest are as follows:
- The floating interest rate is susceptible to change and thus may cause confusion or frustration when the market conditions are volatile.
- The floating interest rate may pile on percentage points when the prevailing interest rates rise, causing a greater financial outlay towards the repayment of home loans.
- Floating interest rate also causes difficulty in borrower’s financial planning.
After weighing all these benefits and drawbacks, you need to make a decision that matches your objectives.
What economic factors affect the floating interest rate?
Several factors influence floating interest. Some important ones are:
- Demand for money: The higher the demand for money, the more the borrowings, hence higher the interest rate which the RBI seeks to control to avoid it spiraling out of control. It is vice versa for lower demand.
- Supply of money: Higher the supply of money, keeping other things constant, the interest rates go down. Thus during times of economic growth when the demand for money is high and supply cannot meet such demand, the interest rates rise and vice versa during recessionary times.
- Inflation: In times of Inflation, interest rates are high and vice versa in times of deflation.
- Global exchange rates: These rates greatly influence domestic interest rates due to a globalized economic and banking system.
- Central Bank policy: The RBI in India is in charge of maintaining interest rates and preventing too many fluctuations. Hence, its policy and decided rates greatly influence interest rates in the market.
What is the difference between the floating-rate and the reducing rate of interest?
Floating rate of interest is a rate of interest that fluctuates as the prevailing interest rates and market conditions change. The floating interest rate is adjusted in response to changes in the prevailing interest rates and market conditions.
On the other hand, a home loan option with a reduced rate of interest is an option where the interest payable is calculated on the outstanding loan amount on a monthly basis. In this method, the EMI payment includes interest payable on the outstanding loan amount along with the principal repayment. After every EMI payment, such an outstanding amount reduces.
In the floating rate of interest, the interest rate fluctuates as the market conditions change, however in the reducing rate of interest, it is actually the outstanding loan amount that reduces after monthly EMI payment.
When availing a home loan, it is not only the rate of interest that you should consider when selecting the lending option. You need to consider the types of interest rates available to you and their effect on the loan amount. These types of interest rate like the fixed interest rate and floating interest can influence your financial outlay towards loan repayment and thus need to be carefully selected.
So, when you seek to avail a home loan for financing your decision of purchasing a house, you need to carefully consider the tenure of the loan, rate of interest, type of interest rate, whether it is the flat balance or reducing balance method and so on before making an informed decision.