What to choose: Fixed or Floating interest rate in Home loans

Fixed or Floating interest rate in Home loans

When you’re looking for a new loan, you’ll come across words like fixed rate of interest and fluctuating rate of interest. Understanding these words, whether it’s for a house loan or a personal loan, may help you make an informed decision about which sort of bank interest rate is best for you, taking into account your financial needs and repayment capabilities. This article will teach you all there is to know about these two words.

What is the definition of a fixed interest rate?

A fixed rate of interest indicates that your interest rate will not change over the term of your loan. It remains unchanged regardless of changes in bank lending rates or the Reserve Bank of India’s repo rates (RBI). The Equated Monthly Installments (EMI) will be the same for the duration of the home loan. Some lenders provide loans with a fixed interest rate for the first few years of the term before transitioning to a variable rate later on.

The Advantages of a Fixed Interest Rate

The following are the advantages of a stable interest rate depending on a variety of factors:

  • Interest rate: Throughout the loan term, the interest rate remains constant and is unaffected by market conditions.
  • Your EMI is set because the interest rate does not change over time, making it easier to manage your monthly budget and long-term financial savings or investments.

Fixed Interest Rates Have Drawbacks

The following are some of the disadvantages of a fixed interest rate:

  • A fixed interest rate is often 1% to 2.5 percent more than a bank’s or non-banking financing company’s fluctuating interest rate (NBFC).
  • Even if the fixed interest rate is reduced as a result of a government or Reserve Bank of India (RBI) decision, the loans already taken out at the prior interest rate are unaffected. Even if the interest rate is reduced, the borrower will be required to continue making payments at the higher rate.
  • Frequently, a fixed rate of interest is only effective for a few years, after which the rate is adjusted to reflect the current rate.

Why should you go with a fixed interest rate?

Here are several situations when a fixed rate of interest may be advantageous to you:

  • You desire a set payback timeline and are willing to pay the current interest rate. You should make sure that your monthly payment does not exceed 30% of your net monthly earnings.
  • You anticipate an increase in the interest rate in the future and want to make sure that your interest payment does not climb more than it is now. The fixed interest rate can be utilized in this situation to lock in the present rate of interest being given by the lender.
  • When interest rates have fallen and are expected to stay the same for a few more years.

What is a Floating Interest Rate, and how does it work?

A floating interest rate fluctuates according to market conditions. The interest will be computed using a base rate with a floating element, so that if the base rate changes, so will the floating rate.

The Advantages of a Floating Interest Rate

The following are some of the advantages of a variable interest rate:

  • Floating interest rates are typically 1% to 2.5 percent cheaper than fixed interest rates given by the same lender.
  • A bank’s or non-banking financing company’s variable interest rates are frequently lower than the fixed rates it gives its clients. As a result, even if the variable interest rate rises, it may still be lower than the fixed interest rate previously given.
  • If the variable interest rate is higher than the interest rate, it will not be for the duration of the loan. After a given amount of time, there is a risk that the floating rates will decrease.

Floating Interest Rates Have Drawbacks

The following are the disadvantages of a variable interest rate:

  • The monthly installments of a specific amount of loan will change over the loan lifetime due to the shifting nature of floating interest rates.
  • It is quite difficult to budget a loan with a fluctuating rate of interest due to the irregular monthly installments.
  • Because this interest rate choice does not allow for a fixed payback timeline, you may end up paying more than you are comfortable with. As a result, you may find yourself with fewer funds and no financial plan.

Why should you go with a floating interest rate?

These are some of the situations where a variable rate of interest may be advantageous to you:

  • When there are good reasons to believe that interest rates will fall in the future.
  • This form of interest rate is typically used by persons who do not have a lot of market knowledge and hence want to adhere to market rates.

In the current environment, where bank interest rates are low, a fixed rate of interest would be preferable over a fluctuating rate. Locking in the rate will be beneficial in planning finances because current rates are already low and unlikely to rise in the near future. If the kind of interest rate is the most important consideration, the borrower should familiarize himself or herself with the various possibilities.