Should I pick a fixed or floating rate of interest when applying for a home loan?

Buying a house needs you take many decisions which can affect your life for years or even decades. Today, getting a home loan is easy but choosing the best options is a difficult task. Moreover, choosing a fixed interest rate over a floating interest rate is a very tough choice as you apply for a home loan.

Fixed rate home loans:

Home loans are generally for long tenures. In a fixed rate loan, the interest rate of the home loan is fixed. The rate is fixed while taking the loan and will remain for the entire repayment term. The home loan will have no change in the interest rate even at the worst economic conditions. There are variants to this. In that case, the interest rate can be fixed for certain years like 2, 3 or even 10 years. This can be reset by the lender at any time.

Fixed interest home loans give a clearer picture to the borrower of how to manage finances from the beginning. This will allow smooth repayment of the loan as the obligations are well known to the borrower as it fixed interest rate home loan.

Benefits of fixed interest home loan:

  1. High inflation phase: Fixed interest home loan is of maximum benefit when the market is at a high peak. In times of high inflation, the fixed interest home loan is very beneficial.
  2. Financial security: The fixed rate home loans provide maximum financial security to the borrower. This is because of the EMI amount as well as the loan tenure if fixed in advance. The interest rate is protected and there is no effect on it even if the interest rates increase.
  3. The option to select the least interest rate among lenders is another added benefit.
  4. Fixed interest home loans are most suited for those customers who do not intend to take any risk with their finances.
  5. These loans give the borrower confidence to plan their budget and finances systematically.

Disadvantages of fixed rate home loan:

  1. The most important disadvantage of a fixed rate home loan is that the interest rate is higher as compared to the floating interest rate. It is about 1- 2.5 percentage points higher than the floating rate.
  2. The other main drawback fixed interest rate is, even if the interest rates drop down the customer has no option to alter the interest rate. The interest rates remain fixed and cannot be lowered even by paying the conversion fees.
  3. In the case of pre-payment or pre-closure, penalty on fixed interest rate home loans is higher. The interest rates are not related to the market rates and the future commitment draws a huge penalty fee as compared to the floating interest rates.
  4. In true sense, the interest rate of fixed rate home loan is not fixed. The borrower has an option to revise the interest rate once in every 3 or 5 years.

Floating rate home loans:

The floating rate home loan is also termed as an adjustable rate home loan. The rate of interest changes as the market conditions keep changing. These are mainly attached to a base rate and have in addition a floating part. Hence, if the base rate fluctuates the floating component also will vary.

Benefits of floating interest home loan:

  1. The floating rate home loan is the best when the market is volatile. Hence during low inflation periods, the floating rate of home loan is preferred.
  2. The rate of interest for floating home loan is 1% to 1.5% lower at the time of availing as compared to the fixed rate home loan.
  3. The good thing is there is no pre-payment penalty with floating rate home loans.
  4. With a floating rate home loan, there is an option to reduce the interest rate or increase the discount. This can be done easily by paying the conversion fees.

Disadvantages of floating rate home loan:

  1. The floating rate home loans are highly volatile. If there is any fluctuation in the base rate it can lead to high EMI or even increase in the tenure of the home loan, though EMI remains the same.
  2. The interest rate calculation is by a non-transparent method.
  3. The interest rate variation among lenders is very high.
  4. The options of low-interest rate lenders are minimum.

Fixed versus floating rate home loans:

When selecting between fixed and floating interest rate, many prefer the floating rate of interest. It is the sole decision of the borrower. Various parameters have to be compared and the final decision has to be taken. Any home loan will have EMI to be paid. If financial security and certainty are of prime consideration then fixed interest rate home loan is the best option.