Becoming a homeowner is probably one of your biggest goals and perhaps the largest investment in your life. It is likely that you may avail a home loan to achieve this goal and purchase the house of your dreams. Availing a home loan is a huge financial decision that affects your life for a long period.
There are several factors you must consider while availing a home loan. One such important factor is the rate of interest as it affects several other aspects of the loan such as the Equated Monthly Installment (EMI), tenure, and borrowed amount.
Most lenders / financial institutions when providing a home loan, offer you the choice between a fixed and a floating rate of interest. As the name suggests, a fixed rate of interest implies that your EMIs remain constant throughout the tenure of your loan. On the other hand, a floating rate of interest would imply that your EMIs would fluctuate basis the market dynamics.
As simple as it may sound, there are important points to consider when opting for a fixed or a floating rate of interest. Below is a brief overview of these two types of home loan interest rates.
1. Fixed rate of interest
Most lenders / financial institutions will offer this type of interest rate for a certain fixed period of time during the course of the loan tenure. At the end of this period, the interest rate changes.
During the period, when the rate of interest is fixed, you may pay the EMI as per the fixed amount. One of the advantages of opting for a fixed interest rate is that you are able to safeguard your EMI against changes in market fluctuations, reducing volatility. This also helps you plan your monthly budget with ease, as you know the exact amount that will be paid in the form of home loan EMI.
However, the disadvantage of choosing a fixed rate of interest is that you are unable to benefit from a decrease in interest due to changes in market condition. This would essentially lead to a reduction in your EMI and subsequently more savings in the long run.
2. Floating rate of interest
The floating rate of interest is volatile and changes with any fluctuation in the market rates. In most cases, a floating rate of interest would be lower when compared to a fixed rate of interest. Moreover, once fixed, the interest will rate will be directly proportioned to the market rate for the entire duration of the loan tenure. A significant benefit of opting for a floating rate of interest is that you are able to enjoy a lower rate when the inflation is on the rise. Moreover, you pay a lower EMI thereby reducing your financial burden. However, when the market rate increases, the floating rate of interest also rises, which in turn raises the EMI.
An example to illustrate the difference between Floating and Fixed Interest Rate
Suppose an individual takes a home loan for 30 Lakhs for a period of 30 years / 360 Months. Let’s say during the application process/procedure the following were the interest rates:
- Fixed Interest Rate: 10%
- Floating Rate of Interest: 9.5%
The monthly EMI in case if you choose a fixed rate of interest would be INR 13,936/- as opposed to INR 12,299/- when you choose a floating interest rate. This implies that you will end up saving INR 1,707/- per month. The amount might seem small at this point but it does make for big savings in the long run. However, the reverse is also true in case the market conditions change and the market rate crosses 9.5%. In that case, you will end up paying a higher EMI amount.
Difference between a fixed and floating rate of interest
|Factors||Fixed rate of interest||Floating rate of interest|
|Interest rate||Fixed for a certain duration||Fluctuates during the entire duration of the loan tenure|
|Market rate||Is not affected by changes in market rates||Directly proportional to market rate changes|
|EMI||Remains constant||Changes based on market rate fluctuations|
One important point is to also consider is that an individual can convert his / her fixed-rate loans into a floating one or vice-versa by paying a small charge/fee. When it comes to choosing interest rates, the majority of home buyers opt for a floating interest rate to take advantage of market fluctuations however, it is highly recommended that you consider your personal needs and financial situation before you make a choice between a fixed rate of interest or a floating one. Also read what is the right time to prepay your home loan only at Finserv MARKETS.
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