Fixed vs. Floating Interest Rates: Choosing the Right Home Loan Type

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26 DECEMBER, 2022

Since applying for a home loan has become more straightforward than it was in the past decade, more people are able to fulfill their dream of owning a house. To encourage this trend, financial institutions are crafting home loan plans with attractive interest rates making them suitable for individuals and co-borrowers alike. Although eligible individuals can obtain a home loan quickly, the choice between the type of interest on home loan often leads to borrowers wondering whether to choose fixed or floating home loan.

There are two types of interest rate in banks, namely fixed and floating interest rate. Read on to understand the difference between the two home loan rate types.

Fixed Interest Rate

As the name suggests, fixed rate home loans are where you as a borrower pay a fixed amount of money as installments over the entire tenure of your home loan. The number of installments remains the same over the decided time period.

Advantages of Fixed Interest Rate

fixed home loan rates in india remain constant and are not affected by market fluctuations

Due to their predictable nature, fixed rate home loans are considered more secure than floating interest rates

Disadvantages of Fixed Interest Rate

They are usually around 1% to 2.5% higher than floating interest rates for home loan

As they remain constant, you will need to pay the same interest rate even if interest rates reduce due to market movements.

If you are willing to have a fixed monthly repayment schedule, a fixed interest rate will be the most suitable option.

Floating Interest Rate

Out of the two home loan interest rate types, floating interest rate changes according to market conditions. Home loans with floating interest rates are bound to a base rate offered by different lenders along with a floating element. Therefore, any change in the base rate influences the floating interest rates, making them change from time to time. Between the two home loan interest rate types, floating interest rates are rapidly gaining popularity among homebuyers and as a result home loan lenders like banks are offering home loan interest rates at attractive floating rates

Nowadays, home loan borrowers take the help of home loan EMI calculator to estimate the monthly installments of their loan. Lastly, the Marginal Cost of Funds based Lending Rate (MCLR) influence the base rates of loan lending organizations. MCLR is a minimum lending interest rate of the bank below which they will not lend money to potential borrowers. Borrowers can compare the two home loan interest rate types and use them to their advantage.

Advantages of Floating Interest Rate

They are less expensive than a fixed interest rate by 1% to 2.5%. They might sometimes be high but it is only temporary as they are affected by the market.

Since they are subject to change they can be used for long-term loans. This way the borrower can enjoy low-interest rates. If the market experiences favorable changes, floating interest rate might decrease hence reducing the total cost of the loan. One more significant advantage of floating rates is that there are no part prepayment and foreclosure charges.

Disadvantages of Floating Interest Rate

The main disadvantage of floating interest rate for home loan is its inconvenience and unpredictability. It keeps changing and is difficult to predict. After a certain point, the borrower might find it difficult to keep up with all the changes.

Since floating interest rate for home loan is subject to change often, it makes financial planning difficult. The floating interest rate for home loan might become too expensive to pay and affect your budget and savings adversely.

Read a Similar Article: How Repo Rates Impact Your Home Loan Interest Rates?

Differences Of Fixed Vs Floating Interest Rate

In fixed interest rate home loan, the interest rate remains the same whereas the floating rates keep on changing. The unpredictability of floating rates does not work in their favour and that’s one of the reasons why many borrowers prefer fixed interest rate home loan. The market conditions do not affect it. Fixed interest rate home loan might sound like a good option but it is higher. However, if you plan carefully, fixed rate home loans are affordable. This type of interest on home loan helps customers feel a sense of security. Whether you choose fixed or floating home loan, it is important to know the key differences between them. When fixed and floating interest rate are compared, they both have their pros and cons:

Difference between fixed and floating interest rate:

Fixed rate	Floating rate
High-interest rate	Low-interest rate
Remains constant	Is subject to change
Allows financial planning	Makes financial planning difficult
Can be used for short term loans	Can be used for long term loans

Now that you know the two home loan rate types, you can take an informed decision.

Why are Floating Interest Rates Better?

Lower interest rates

Floating rates are usually slightly lower than fixed interest rates. Lenders charge more for fixed interest rates to cover their interest risk for the entire tenure. While it depends on the lender, the difference can be between 250-400 bps. Therefore, while you might think that the fixed interest rate would be cheaper due to its fixed nature, the total interest outgo can be much higher in the longer run.

No prepayment charges

As per Reserve Bank of India's mandate, lenders cannot charge a prepayment fee on floating interest rate home loans. Therefore, if you plan to prepay your home loan, you would not need to pay any foreclosure charges. Usually, the prepayment charges are 2% of the outstanding loan amount. However, this concession is not applicable on fixed interest rate home loans.

More choices

Lately, very few lenders offer fixed interest rate home loans. Therefore, you have limited choices in fixed interest rate home loans. While a few lenders offer hybrid loans where fixed interest rates change in floating after a few years, it is not usually recommended.

Transparent

Floating interest rates have more transparency and flexibility. They are cost-effective and provide you flexibility in benefiting from competitive pricing structures. It also helps you easily opt for a home loan balance transfer.

Though floating interest rates are uncertain and keep changing throughout the tenure, they are usually cheaper and cost-effective. Therefore, you must research both home loan interest types before you apply for home loan. If you are confused, it would be best to consult a financial advisor and then decide.

Choosing Between Fixed and Floating Home Loan Interest Rates: What's Best for You?