Fixed or Floating Rate Housing Loans – which one is better
"Home loan" without doubt the biggest loan you ever have taken in your life. Home loan is long term commitment in which the borrower has to pay monthly instalments for many years. As such the decision for choosing type of interest rate is very critical. There are two options for borrowers fixed interest rate or floating interest rate. Whether to choose a fixed rate home loan, which is easy to budget and has an element of certainty with it or to choose a floating rate of interest that provides the benefits of decreased interest rate, is a tough decision that has confused home loan seekers for long. Here I will try to explain the benefits and drawbacks of both the fixed and floating rate home loans.
Fixed interest rate means that the interest rate remains same for the entire tenure and is not affected by the changes in the interest rates by RBI. The EMI and tenure remains the same. Fixed interest rate is higher than floating interest rate. However there is a clause through which banks can increase the interest rate after some stipulated time period subject to certain conditions.
As per the present rule the Housing Finance Companies (HFCs) and Banks not to levy penalty on pre-closure of floating rate home loans even if the pre-payment is made through funds borrowed from other banks and finance companies(some of the banks yet to implement this RBI direction, they are waiting for RBI's official circular). However Banks/HFCs are allowed to charge appropriate penalty on the pre-closure of fixed interest housing loans.
Floating interest rate means that the interest rate keeps fluctuating according to the economy trends. If the interest rate rises, the necessary adjustments will be made in the EMI and loan tenure. Same is true if the interest rate falls.
Getting a home loan is very easy now a days, however choosing the best option is always a complex aspect. One should do a proper homework before rushing in to something. While applying for a home loan, the first thing which will bother the applicants is whether to go for Fixed Interest rate or Floating Interest rates?
Let us see which option is better after analyzing the advantages and disadvantages
| | Fixed Interest Rate on Home Loan | Floating Interest Rate on Home Loan |
| What is Fixed and Floating Interest Rates? | Fixed Interest Rate means repayment of home loans in Fixed Equal Installments over the entire period of loan. In this case the interest rate doesn't change with Market fluctuations. During the early part of loan tenure the majority of monthly payments are used to service the interest and principal is served in the later parts of loan tenure. | Floating rate by the name implies that the rate of interest varies with the market conditions. Floating interest rate home loans are tied up to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies. |
| Advantages | - Interest Rate remains fixed irrespective of Market Conditions.
- A fixed rate home loan is excellent for those who are good at budgeting and want a fixed monthly repayment schedule, which is easy to budget and doesn't fluctuate.
- It brings a sense of Certainty and Security.
| - The biggest benefit with floating rate home loans is that they are at least 1%-2% cheaper than fixed interest rates. So, if you are getting a floating interest rate of 12.00% while, the fixed loan is being offered at 13.50%, you still save money if the floating interest rate rises by up to 1.5.0%.
- Even if the floating rate goes over the fixed rate, it will be for some period of the loan not for the entire tenure. The interest rates will surely fall over a long period and thus floating interest rate brings a lot of savings.
- No pre-payment penalty is applicable (most of the banks yet to implement)
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| Disadvantages | The major drawback with fixed rate is that it is usually 1 - 2.5% more than the floating rate home loan. Secondly, if for any reason the interest rate decreases, the fixed rate home loan doesn't get the benefit of reduced rates and the borrower has to repay the same amount every time. Another area of concern is whether the fixed rate home loan is 'truly fixed' or fixed for just few years. This has to be ascertained while taking the home loan. A 'fixed' home loan, which can be changed every few years, will definitely wipe out the very spirit of such a loan. Experts agree on the fact the fixed rate are a better option if the economic scenario promises a rise in interest rates in near future. Pre-payment penalty is applicable | The drawback with floating interest rate is the uneven nature of monthly installments. This makes it difficult to budget with floating interest rate home loans. As seen in recent times due to the hike in floating home loan interest rates, the borrowers had to shell out thousands per month extra as their EMI's, throwing their entire budget out of order. |
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The difference can be explained with the help of an example
Loan Amount Rs. 30,00,000.00
Loan Period: 20 years
Floating Interest Rate is 9.50% /Fixed Interest rate is 10.5%.
If you take a home loan with floating interest rate then the EMI (Equated Monthly Installments) will come to around Rs. 27,964.00, whereas the EMI under the Fixed Interest rate option will be Rs. 29,951.00. So, monthly you may end up saving around Rs. 1,987.00. Though this amount looks small, it will make a big difference in the Long Term in case the interest rate goes up.
The following table shows EMI for Rs. 25, 00,000.00 home loans for different payback periods with different rate of interest
| Calculations |
| | Interest Rate (%) |
| Years | Months | 9.50 | 10.00 | 10.50 | 11.00 | 11.50 |
| 16 | 192.00 | 25,375.00 | 26,148.00 | 26,931.00 | 27,725.00 | 28,529.00 |
| 17 | 204.00 | 24,745.00 | 25,530.00 | 26,327.00 | 27,135.00 | 27,952.00 |
| 18 | 216.00 | 24,198.00 | 24,996.00 | 25,806.00 | 26,626.00 | 27,457.00 |
| 19 | 228.00 | 23,721.00 | 24,531.00 | 25,353.00 | 26,187.00 | 27,030.00 |
| 20 | 240.00 | 23,303.00 | 24,126.00 | 24,959.00 | 25,805.00 | 26,661.00 |
| 21 | 252.00 | 22,936.00 | 23,770.00 | 24,615.00 | 25,472.00 | 26,339.00 |
| 22 | 264.00 | 22,612.00 | 23,456.00 | 24,313.00 | 25,181.00 | 26,059.00 |
| 23 | 276.00 | 22,324.00 | 23,180.00 | 24,047.00 | 24,925.00 | 25,815.00 |
| 24 | 288.00 | 22,069.00 | 22,935.00 | 23,812.00 | 24,701.00 | 25,600.00 |
| 25 | 300.00 | 21,842.00 | 22,718.00 | 23,605.00 | 24,503.00 | 25,412.00 |
Assumptions - The interest rate remains fixed during the loan tenure, Interest rate is compounded monthly, Processing & other charges which may applicable as per the rules of banks and other lending institutions are not taken into account.
Another advantage of house property investment is that, the principal and interest payments made every year for a home loan availed in India are allowed as deductions subject to an overall limit of Rs 1 lakh per year on principal payments (under section 80C) and full interest payments made during the year (under section 24b) - in case of let-out property.
Conclusion
Most of the banks and financial institutions allow their customers to change it afterwards, if they want to. So if you are having a Fixed Interest Rate Loan, you can switch to Floating Interest Home Loan and vice-versa. But, it is not free and there is a cost associated with the same (all banks yet to implement RBI direction related to pre-payment charges of floating rate hosuing loans), so it is always better to take a thoughtful decision at the start i.e, at the time of applying for the loan. Try to compare the interest ate that your Bank/Financial-Institution is offering for Fixed and Floating rate home loans and weigh it against your loan-tenure. If you are going for a long tenure and don't want to take any risk, then a Fixed Rate Home Loan is recommended. But if you go for short tenures, then you should opt for Floating Rate Home Loans. In the short term, interest rates may not fluctuate much, so paying a 1.5-2% (or even more) premium for a Fixed Rate Loan is not a very good idea. At present, over 80-90% of the home loan borrowers opt for Floating Rate Home Loans also there is one option now available for the pre-closure of floating rate home loans without any penalty.
Best Regards
Prakash Nair
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