Fixed or Floating: Which Home Loan Interest Rate You Should Opt For?

If you are planning to apply for a home loan, here are a few tips to help you decide between floating and fixed interest rate.

Deciding between floating and fixed interest rates is quite a dilemma for many homebuyers. Whether you are looking to fund your education, business or a new home, the interest rate choice is a crucial step in the process of financing your needs. While applying for a home loan, you can either choose a fixed interest rate or a floating interest rate. In this blog post, we’re discussing the factors you should consider to make a suitable choice.

A fixed interest rate means you repay your loan amount with a fixed percentage of interest and in Equated Monthly Instalments (EMIs) for the entire tenure. The methodology is considered safer because it provides protection against fluctuations. On the other hand, a floating interest rate implies that the rate of interest is subject to revisions depending on economic scenarios. The rate was earlier linked to the marginal cost of funds-based lending rate (MCLR) but now it’s pegged to an external benchmark, the base rate.

Following this logic, if the interest rate in future economic cycles is expected to rise, it is advisable to opt for a fixed interest rate on your borrowings. However, it is important that you read the terms and conditions attached to your loan documents since certain banks can reset the interest rate or link to a floating rate after a fixed period of time.

A fixed interest rate provides the advantage of rate stability throughout the tenure (with some exceptions) which in turn helps you calculate the required budget for easy repayments. However, if the interest rate cycle goes down, you cannot access the benefits related to the lower rate of interest. You could opt for a fixed home loan interest rate if you prefer to go for a fixed repayment schedule and if your proposed EMI is less than 30 per cent of your monthly income. It’s a safer option as it shields you from interest rate fluctuations in the market.

While a floating rate seems like a gamble, it has many other benefits. Floating interest rates are typically 1 to 2.5 per cent lower than the fixed rates. Choosing a floating rate can result in savings over the loan tenure since the rate varies in accordance with the interest rate cycle fluctuations. However, the downside of floating rate option is that it becomes difficult to plan out and budget your finances over the tenure of the loan. It could be a challenge to arrive at an accurate prediction of your future monthly payables. You must choose a floating home loan interest rate if rates are expected to go down in near future or if you want your repayments to depend on market rates due to a lack of expertise on interest rate cycle fluctuations.

Choosing between a floating or fixed rate loan is a very important decision which should be made only after taking into account various factors, including your ability to take the risk. While both types of interest rates come with their own set of pros and cons, you should select the one that complements your requirements the most. The fixed interest rate can give you a sense of security and ease your mind; while its counterpart could help you access unexpected financial gains arising out of interest rate fluctuations.

You should also consider various loan plans available with the concerned financial institution before making the final decision. If you are still not sure as to which interest rate type suits you the best, you have the option to take on a loan and change between the fixed and the floating rate at a later date. However, many lenders levy a nominal fee for switching the interest rate type. Even as your choice of interest rate impacts the cost of acquiring an asset through loans, you have the flexibility in selecting the right type throughout the tenure as per your financing needs.