Should You Opt a Floating Rate Home Loan? Or a Fixed Rate Home Loan?

Say, you have come across that house you have been looking for—the perfect locality, the perfect architecture, the perfect price, and to your surprise the papers are all just right! Now, you approach a bank and get into the process of understanding the inner details of how a house loan works. 

In this situation, you are sure to encounter the dilemma of choosing between a floating interest rate and a fixed interest rate. Which one is beneficial for you? Which one among the two will turn out to be the right choice? Which one will cost you less?

To help you make the right choice, we give you a brief on how each of them works.

Floating Interest Rate

Your home loan’s interest rate will vary based on the change in the repo rate, as suggested by the Reserve Bank of India (RBI) from time to time. How will this affect you? When the repo rate goes up, your instalment will rise too. Similarly, when the repo rate falls, the corresponding month’s instalment can be light on your pocket. 

When you choose this type of home loan, there are possibilities that you save when the repo rate is down and that you pay more when the repo rate is high; this is in comparison with the fixed-rate home loan. 

Further, read through your loan agreement thoroughly. You will find a clause regarding the reset period of the interest rate, i.e. a fixed interval over which the floating rate may change. 

Every time there is a change in the repo rate, the bank may suggest a different instalment amount or a different loan tenure in proportion with the interest rate change. If you are ready for this dynamic nature of the loan, you can go for it.

Fixed Interest Rate

As the name suggests, the interest rate, in this case, will be decided on before you take the loan. The bank will suggest this interest rate based on factors, such as your credit score, your income, other existing debts you have, and the loan repayment capacity. 

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Note that the interest rate will not change based on the market variations or repo rate. You will have to repay the loan amount in equated monthly instalments (EMI), i.e. pay the same amount of monthly instalments throughout the loan tenure. 

This approach suits people who would like to have a planned way of dealing with things. Since the monthly instalment amount will be known in advance, you can plan your finances accordingly for the duration of loan repayments.

Floating Rate Loans vs Fixed Rate Loans

Prepayment Option

The prepayment option specifies that you can pay the outstanding loan amount in full well before the loan tenure to free yourself from the routine of monthly payments. 

Say, your friend paid back that money he had borrowed from you a few years ago. You have excess cash at hand. Then, why pay monthly instalments and let your money go in the form of interest payments? Instead, you can pay off that huge amount you have received towards the home loan and relieve yourself from the loan a little sooner. Sounds good right?

This option is available when you take the floating interest rate home loan. In contrast, even if you pay off the outstanding debt in a single lump-sum payment towards your fixed interest rate home loan, the bank will ask you to pay a prepayment penalty equal to the interest you would pay until the end of the tenure. This penalty is charged so that the bank does not miss out on receiving interest payment from your end.

There is no way to have a clear-cut say on which type of home loan is more beneficial to a borrower. Consider all the factors we have discussed to conclude the right option for you based on your financial situation and goals. Make the right choice for yourself and spend a happy time at your perfect home!

For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in