Interest rate is the most critical part of your home loan as it determines the cost of borrowing. While taking home loan, you may required to decide between fixed and floating interest rate that your bank offer.
You need to do proper homework before rushing into bank for a home loan. Choosing the best option out of these two is always a complex matter. Let us discuss both options in this article.
Fixed Interest rate
Fixed interest rate on your home loan is revised after a fixed period of time depending on bank’s decision otherwise it uses to remain fixed for a period.
The interval period could be every two years or three years, depending on the bank or financial institution. Under this option you pay fixed equal monthly installments to your bank over a period of time until the rate has been revised by bank.
Generally, fixed interest rates are not revised as it uses to be in the case of a floating scheme but does not mean that it will be remain same for the whole period of borrowing.
As you pay most of your interest portion in early part of your home loan, by the time fixed rate changes it will not affect that much to your cost of home loan.
Fixed rates are decided by taking future expected floating interest rate and loans are also issued in a manner that the present value of loan at fixed interest will be equal to the expected present value for the loan at floating interest.
Floating interest rate
Floating interest rate will change with the change in bank’s base rate. If bank’s base rate is 10.5% per year then floating interest percentage will be decided by adding a premium to it.
Such premium portion will be decided based on your risk factor. If lending to you is less risky then bank may charge lesser premium by which your floating interest percentage will come down.
It can be changed every quarter or half yearly or yearly based on the prevailing market conditions.
Both have their own advantages and disadvantages. Fixed rate remains constant for a period and never decline with the decline in base rate whereas floating interest rate will come down with the decline in base rate.
To know which one will be beneficial, you need to look into the future interest cycle of the economy. If interest cycles are likely to be increased in future then it’s better to consider fixed interest rates as it will not move in that ratio to the changes in interest cycle.
Similarly, if your expectations are that it will fall in near future then floating rate will be a better option for you as it will fall with the decline in based rate.
Some lenders have option of sifting from fixed to floating and vice versa. If you have taken home loan from such lenders then consider sifting between fixed and floating. For a better visibility keep tracking of the interest cycle moves and change your decisions accordingly.
Usually fixed interest rates are 1% -2.5% higher than floating. If you are thinking that during your home loan tenure base rate of a bank will go up by that ratio then consider opting for fixed rate otherwise floating is a better choice. If floating goes over fixed interest rate then it will not be for a long period. Even one can try to sift between these at a frequent interval based on the market conditions and limitations of lender.
It’s up to the borrower to decide which interest rate to avail based on the market conditions and their requirements. In India majority borrowers are opting for floating interest rate.