Fixed vs. Floating Interest Rates

Home Loans are one of the simplest ways to finance a property purchase if someone wishes to buy a home. These days, getting a home loan is not a difficult task but deciding between floating and fixed interest rate can be a difficult choice. It's crucial that you consider both the interest rates, weigh the pros and cons, analyze the market predictions and then make an informed decision. If you are entirely new to the field and have no idea what these terms mean, read on to get a basic idea.

What is a Fixed Interest Rate?

If you choose a fixed interest rate, you'll be paying the same amount of interest rate each month. This type of interest rate is unchanged by market fluctuations. If you are particular about budgeting and prefer planning your repayment schedule with a fixed monthly amount, this type of interest rate would be more beneficial for you. The main drawback of a fixed interest rate is that that they usually are 1-2.5% higher than the floating interest rate for a home loan. Another disadvantage is that if the interest rate decreases, you won't be able to take advantage of the decreased rates and you will have to continue paying the original amount. It is essential that you check the fine print. If you see the economic scenario assuring a rise in interest rates shortly, fixed rates would be a better option as compared to floating rates.

Benefits of Fixed Interest Rate

• As the name hints, fixed interest rate continues to remain constant for the loan tenure. This interest rate doesn't alter depending on the rise and fall in the market.

• Since this type of interest rate doesn't shift over time, you will have to pay a fixed monthly installment over the tenure. Therefore, you can efficiently and accurately plan your investments under this type of rate of interest.
• It is the best alternative for people who are skilled at budgeting and favor a fixed EMI schedule.
• If the economic conditions imply that there are possibilities of a rise in the interest rates in the future, paying back the loan with a fixed interest rate is an excellent option.

Drawbacks of Fixed Interest Rate

• The fixed interest rate is usually 1% -2.5% greater than the floating interest rate granted by a bank or NBFCs.
• Even if the fixed interest rate decreases after policy changes suggested by Reserve Bank of India (RBI), it doesn't modify the loans that are already borrowed by using the prior interest rate. The borrower will be required to continue repayment at the higher interest rate even after a rate cut.
• Many a time, the fixed rate of interest is valid for a couple of years. In such cases, after the tenure is over, the interest rate will get updated depending on the current rate. This might not be a practical plan in the long run.

Why choose a Fixed Interest Rate?

The reasons why you should choose fixed interest rate are given below:

• If you prefer a fixed repayment and you're comfortable paying the current interest amount, then you should ensure that the monthly installment that you pay towards the loan isn't more than 30% of your monthly salary.
• You predict a rise in the rate of interest in the future and want to assure that your interest amount doesn't rise greater than what you are currently paying. In such case, the fixed interest rate can be used to secure the current rate of interest.
• In case there has been a decline in the interest rates recently, and you are content with repaying your loan at the present rate, you can choose the fixed interest rate while repaying the loan amount.

What is Floating Interest Rate?

As the name infers, the floating interest rate alters with the market fluctuations. If you choose to get a home loan on the floating interest rate, it means that you'll be constrained to a base rate and a floating component will be added to the base amount. This implies that if the base rate changes, the floating rate will also change. The main highlight of the floating interest rate is that they cost the investor less than the fixed interest rate. If the fixed interest rate is 14% and the floating interest rate is 11.5%, even if the interest rate increases by 2%, you will be saving money. Even if the floating interest rate increases over the fixed rate, it will be short-lived, and not for the entire term of the loan. The main shortcoming of the floating interest rate is that it is challenging to manage a budget since the rate of interest keeps changing frequently. Planning your finances for a long-term could get complicated with a floating interest rate.

Benefits of Floating Interest Rate

• The floating interest rates granted by a bank or non-banking financing company (NBFC) is usually more economical than the fixed rate it offers to its customers. Therefore, it means that even if the floating interest rate increases, it can still be less than the previous fixed interest rate offered.
• If the floating interest rate caps the fixed interest rate, it won't happen for the entire loan tenure. There are possibilities that the floating rates might get lower after a period.

Drawbacks of Floating Interest Rate

• Due to the fluctuating nature of the floating interest rates, the monthly installments of a distinct amount of loan will alter throughout the tenure of the loan.
• Budgeting can be a major problem if you've chosen floating interest rates. Since the interest rate keeps changing, you might end up paying more than the amount that you would've paid under a fixed interest rate scheme

Why choose a Floating Interest Rate?

• You can choose a floating interest rate for your loan when you understand that the rates might lower in the future, thereby, decreasing the total cost of the loan.
• Sometimes, the interest rates under floating rates are set as low as 1-2% under the fixed interest rate.
• This type of interest rate usually befits people who do not hold enough insight into the financial market and, thus, want to cling to the market rates.

In conclusion, selecting the type of interest rate that you should go for is an individual's choice. What works for one person may not certainly be the best choice for someone else. If you prefer to plan your finances and not leave anything to chance, the fixed rate of interest would be better suited for your needs.