Looking to buy your dream house? For most of us, buying a house involves exploring the market for the right property, conducting the due diligence of the property and finally securing a home loan to fund the purchase.
Before taking a loan, you must know about various home loan products available in the market. Comparing home loan interest rates of various lenders and picking the cheapest one is not enough.
If you do not understand the difference between fixed-interest home loans and floating-interest home loans, you might pick the loan product that is not fit for you. Given that home loans generally involve big amounts and long repayment tenures, a wrong decision can make a big dent in your pocket.
Fixed-Rate Home Loan
A fixed-rate home loan, as the name suggests, offers you the comfort of a constant monthly outgo as home loan instalment for the entire tenure. You can stay at ease even when home loans become expensive in a market with limited availability of money.
On the flip side, lenders offer fixed interest rates by taking the future interest rate outlook into account. Fixed interest rates are generally 0.5-1.5 percentage points above the existing floating interest rates to compensate for the risk of rate fluctuations.
Ironically, fixed rate home loans do not always offer 100% protection against future interest rate hikes. Many banks and housing finance companies offer fixed interest rates only for a specified duration. The interest rate is revised to reflect the prevailing market scenario after this period. Many lenders also include the interest rate revision clauses in their loan agreement.
If you are looking for a truly fixed interest rate of the entire tenure of the loan, make sure you pick a loan product which does not include provisions for rate revisions.
Fixed home loans generally come with a higher cost: pre-payment penalties. You might also have certain restrictions on partial pre-payment of loans.
Floating-Rate Home Loan
Lenders offer floating rate home loans which give you the advantage of paying interest based on the rate in the general market. Interest rate of such loans are linked to the base (lending) rate of the lender, which in turn is decided based on various factors driving the financial market.
Base rate of lenders are reviewed at least once every three months (quarter) according to the guidelines of the country’s central bank. Your home loan EMI will increase (or decrease) if the lender revises its base rate.
Despite the disadvantage of a frequent increases in the loan repayment EMIs, floating-rate housing loans are more popular. You don’t have to worry about any prepayment charges when you opt for a floating-rate home loan. You do need to keep a constant tab of your home loan interest rate.
FIXED OR FLOATING HOME LOAN
Being familiar with the concept of fixed and floating rate home loans, you have to decide which loan option is beneficial. The right answer requires a holistic approach based on the economic outlook as well as your personal finances and future plans.
In case the existing interest rates are high and a fall is expected in near future, you should take a home loan on floating rate. If the interest rates are likely to go up steeply, you should opt for the fixed rate option.
Looking into the historical data of interest rates should help you take the call. You can go for a fixed rate home loan if the interest rates are significantly low from their past.
You should also factor in the risk that you are willing to take. If you are risk-averse and the fixed interest rate is low enough to enter into a long-term contract, you will have the surety of a fixed home loan EMI even when interest rates peak.
Taking a call on a fixed rate loan is easy when your repayment tenure is small. For long-term loans (10-30 years), it is safer to go for the floating rate option.
If you want the best of both worlds, get your home loan with the mix of both fixed and floating rate loans.