Fixed Interest Rate vs Floating Interest Rate
Interest rates on home loans are one of the most important factors that every prospective borrower considers before applying for a loan. One of the most important factors to consider when finalizing the desired home loan deal is the interest rate offered by financial institutions.
Making a decision based solely on the interest rate percentage complicates matters because interest rates are further classified into two types: fixed interest rates and floating interest rates.
Customers who apply for a home loan have the option of selecting either type of interest rate. Therefore, we must thoroughly understand the meaning of fixed and floating interest rates, their benefits, and when you should choose them to know which is a better option.
Fixed vs Floating Interest Rate: Comparison
| Fixed interest rate | Floating interest rate |
|---|---|
| The interest rate is higher. | The interest rate is lower. |
| Untouched by financial market fluctuations. | Susceptible to changes in the financial market. |
| Monthly installments are fixed. | Monthly installments vary according to the interest rate. |
| Easy to plan and manage finances and/or budget. | Planning and managing finances and/or budgets are difficult. |
| Gives a sense of security. | Helps in generating savings. |
| Ideal for a medium/short term. | Suitable for a long tenure. |
What is a Fixed Interest Rate?
The term "fixed interest rate" refers to the fact that the lending rate is fixed for the duration of your loan. Fixed interest rates are typically 1% to 2% higher than current floating interest rates. Fixed interest loans give you a sense of security because you know your monthly payments and loan terms ahead of time.
Keep in mind, however, that fixed rates on long-term loans, such as loans against property, may convert to floating interest after a few years, depending on your lender's terms. This is known as a reset.
People who choose fixed interest rates must repay their loan in fixed and equal installments over the loan term. A fixed interest rate does not change even if the Indian financial market conditions or trends change. When the financial market is in a slump, fixed interest rates become the preferred option.
Consumers take advantage of this opportunity by blocking or securing their preferred interest rate. In simple terms, if you believe that the financial market will not fall below a certain level or that interest rates will rise, then a fixed interest rate is the best option to consider.
Benefits of a Fixed Interest Rate
- Regardless of market conditions, the interest rate remains fixed. This provides the best protection, especially in volatile conditions.
- Fixed interest rates on home loans are ideal for those who are good at budgeting. It is also an excellent choice for long-term budgeting.
- It also aids in long-term planning by providing certainty and security.
When Should I Choose a Fixed Interest Loan?
If you are comfortable with your EMI and do not want any surprises, a fixed interest rate is ideal for you. To ensure that you meet the EMI payment deadlines without difficulty, try to keep the EMI at 25% of your salary or less.
Fixed interest loans allow you to better plan your finances because the EMI and tenure are predetermined. It is also useful when you do not want to take market risks associated with fluctuations in the interest rate.
Customers in their late 40s prefer fixed interest rates because they have plenty of time before retirement. They are safe in terms of interest rate increases or EMIs.
What is a Floating Interest Rate?
A floating interest rate means that the interest rate is subject to quarterly revisions. The interest rate on your loan will be tied to the base rate, which is set by the RBI based on a variety of economic factors. The interest rate on your loan will fluctuate in response to changes in the base rate.
Any changes in the interest rate during the loan's tenor will have no effect on the EMI; instead, the tenor of the floating interest loan will vary. According to RBI rules, lenders cannot impose a prepayment penalty on loans with floating interest rates.
Floating interest rates are volatile and change according to market conditions. This type of interest rate is determined by the base rate offered by various lenders, so when the base rate changes, the interest rate is automatically revised.
Floating interest rates are less expensive than fixed interest rates. The fluctuation in the floating interest rate is only temporary, as it is determined by market trends.
Benefits of a Floating Interest Rate
- A floating interest rate is lower than a fixed interest rate.
- If your floating interest rate rises, it will only be for a short period of time. It will not be valid for the entire term of your loan.
- The loan repayment period is reduced. As a result, it is an excellent choice for those who will need additional loans in the near future.
When Should I Choose a Floating Interest Loan?
Choose floating interest rates when you believe the base rate will either remain constant or decrease over time. In this case, the interest rate on your loan will either decrease or remain unchanged.
Choosing a floating interest rate also allows you to make prepayments with extra income, which can help you pay off your loan faster and even reduce the total interest charged. So, if you expect your income to rise in the future, a floating interest rate may be a better option.
People in their late twenties should choose a floating rate of interest because they have plenty of time to repay the loan. They may also experience a plunge in interest rate several times during the loan tenure.
Can I Change from Floating to Fixed-Rate or Vice-Versa?
It is possible to change the interest scheme from floating to fixed rates, and vice versa. When switching, keep in mind that you may be charged a fee. Lenders charge a conversion fee of up to 2% of the total loan amount to switch from fixed to floating interest rates (or vice-versa).
The decision between a floating and fixed interest rate is significant because it affects your EMI. So, do your homework to make an informed decision that best suits your financial situation and needs.
Conclusion - Which is a better option?
No loan scheme can be said to be better than another. Whether you choose a fixed or floating home loan interest rate, depends on your needs, preferences, and financial situation. To choose the best option you should compare loans based on various parameters and understand every detail about it.
Though the loan you choose has a significant impact on the final cost of your home, you have the flexibility to change how interest is charged on your home loan depending on the circumstances.
