Exploring Home Loan Options: Fixed Rate vs. Adjustable Rate

Homebuyers planning to facilitate their home purchase with a home loan are often told to negotiate hard and try and avail of a low home vs. Floating Home Loan Interest Rates: What's the Difference Between the Two?

Fixed home loan interest rates are interest rates that do not vary with varying market conditions. They are independent of the external market conditions and remain the same through the tenor of the loan. Floating interest rates, on the other hand, are linked to an external benchmark and change with changing marketing conditions. These days, most floating interest rate loans are linked to the Repo Rate, which is the rate at which the central bank of the country, i.e. the Reserve Bank of India lends money to the commercial banks and lenders. 

When interest rates are linked to the Repo Rate, borrowers' EMIs go up every time the Repo Rate goes up and the EMIs go down every time the Repo Rate goes down. Thus, in the case of floating interest rate loans, the housing loan interest rates and, therefore, the loan EMIs fluctuate with fluctuating market conditions. The real question here is: fixed vs. floating, which home loan rate regime would be a better choice for you. To answer this question, we must first look at the advantages and disadvantages of fixed and floating interest rate loans.

FixedInterestRateLoans: Advantages and Disadvantages 

Advantages 

 The biggest benefit of a fixed interest rate home loan is that in the case of these home loans, the loan EMIs do not change with changing market conditions. Thus, in the case of fixed interest rate home loans, monthly budgeting and loan repayment planning prove to be much easier than in the case of floating interest rate loans. Your EMI remains the same through the tenor of the loan and therefore, you know well how to do monthly budgeting and where to cut corners to make sure you have enough money to clear your EMI at the end of each month.

 Fixed interest rate home loans prove to be a boon in two conditions. First, when interest rates rise and everyone else is having to pay a much higher EMI, fixed interest rates help home loan borrowers keep their loan EMIs affordable. Further, sometimes, life does not pan out as planned. You may have imagined that your income will grow considerably over time, but circumstances can sometimes prove unfavourable. Repaying a fixed interest rate home loan is much easier when your income stays constant and does not increase with time. 

Disadvantages 

 Fixed home loan interest rates carry higher risk for lenders than floating interest rate loans. Therefore, lenders charge a higher rate of interest on fixed interest rate home loans and therefore, fixed home loan interest rates tend to be more expensive. Expect to pay 1% to 2% higher interest rate than floating interest rate home loans in the case of fixed interest rate home loans.

Fixed interest rate home loans can prove to be disadvantageous if home loan interest rates go down. In this case, while those on fixed interest rates will pay lower EMIs and save money, you will be forced to repay your home loan at a much higher rate of interest.

FloatingInterestRateLoans: Advantages and Disadvantages 

Advantages 

People prefer floating interest rate home loans as they are cheaper than fixed interest rate home loans. In general, lenders charge 1% to 2% lower interest rate on floating interest rates as compared to fixed interest rates. They do so to encourage home loan borrowers to opt for floating interest rates as these floating interest rate loans are a less riskier deal for lenders. When home loan interest rates go down, so does the home loan of people on floating interest rates. This helps people save more during low interest rate phases.

Disadvantages 

The problem with floating interest rate home loans is that budgeting becomes quite difficult as loan EMIs keep varying. Therefore, you never know how much will go in loan EMIs each month. Further, if the circumstances are not in your favour, paying your EMIs may become difficult during interest rate peaks and hikes. 

FinalWords 

Between fixed and floating interest rate loans, it is better to opt for floating interest rate loans since they are cheaper. However, if you study markets and are convinced that home loan interest rates will go down in the short term and stay on the lower side, you should consider opting for a fixed interest rate loan. Whichever home loan type you choose, remember that a housing loan is a long-term commitment, and life can be quite unpredictable. 

Therefore, it is best to set aside an emergency fund if you are repaying a home loan. Ideally, borrowers should keep six months' worth of EMIs in their emergency fund. This emergency fund will prove most useful during a financial emergency or if life doesn't go as planned, which is often the case.