Which type of home loan do you prefer? Is it a fixed rate or a floating rate? If you are willing to purchase a home for the first time, you may not have adequate knowledge about these two types of housing finance options offered by both public and private lenders in India. You have to understand the nature of each loan option and in which way they can be beneficial for you. A wrong decision may harm your financial position in the long-run.
Fixed rate loans
The interest payment is an integral part of the loan. The borrower agrees to pay interest at a constant rate in case of a fixed rate home loan. The interest rate remains the same throughout the loan term and does not fluctuate with market trends. It is determined by lenders on the basis of the average discount rate over the fixed rate tenure. For instance, fixed rates are more than variable rates when the discount rate is historically low. On the other hand, lenders offer borrowers a discount in order to set their interest rate when interest rates are historically high.
Merits and demerits of fixed rate loans
The primary benefit offered by constant rate loans is certainty in terms of future payments. Borrowers can easily schedule their future financial obligations, thereby retain their budgets unaffected. They can retain a low-interest rate for a fixed term when interest rates are very low. This loan option also has a few demerits. The loan option does not allow borrowers to benefit from decreasing interest rates. If the borrower wishes to avail the benefit of falling rates, the loan should be refinanced. Unlike a floating rate loan, a fixed rate loan has no lesser introductory loan.
Variable rate loans
A variable rate home loan does not have a constant rate of interest throughout the tenure. Interest rates will fluctuate based on a benchmark rate. The London Interbank Offered Rate (LIBOR) is the most commonly used reference rate. The yield curve lowers the cost of a variable rate home loan over a fixed rate home mortgage. Borrowers take the interest rate risk for remitting a lower loan rate. If the rate of interest drops, the borrower will be benefited. Conversely, if the rate of interest goes up, then EMIs will also upsurge, and thus the loan becomes expensive.
Merits and demerits of variable interest loans
Variable or floating interest rate loans have more flexibility over constant rate borrowings. Borrowers do not have to worry about penalties if they wish to prolong and settle their mortgages. They can benefit from decreasing interest rates. The flexibility offered by this loan option allows borrowers to save a good amount of money over the course of their mortgages. If market movements turn in the borrower's favor, they can further strengthen their financial health. Variable rates do not offer predictability and steadiness. It is always complicated to comprehend the movements in interest rates. If interest rates start moving in an upward direction, the cost of the loan will increase for the borrower.
Which option is better?
Whether to select a fixed rate mortgage or a floating rate mortgage depends on your requirements, financial positions and preferences. It is ideal to choose a constant rate mortgage if Interest rates are envisioned to increase, you are comfortable with the EMI you are promising to remit (not exceeding 20-30% of monthly earnings) and Interest rates have slashed recently. Conversely, you can choose a floating rate loan if interest rates are expected to drop in the future, you are not confident about movements in home loan interest rates and you are seeking for some savings on your interest expenses in the near tenure.
Both home loan options have their own merits and demerits. A floating rate mortgage offers the advantage of reduced interest rates whereas a fixed rate mortgage enables you to clearly plot your budget. Borrowers have an option to switch between these two types of financing options for a nominal fee. They can select a combination loan, which is partly fixed and partly variable. This option is extremely instrumental when borrowers have other loan obligations currently.