The process of financing a home can be tiring and time-consuming for home buyers. To make an informed decision, it is important to understand which type of interest rate regime is most suitable for your needs.
Your two financing choices are fixed interest rate financing and floating interest rate financing.
How fixed-interest financing works
A fixed interest rate means that the interest rate you are charged will be the same throughout the term of the loan, regardless of any changes in market rates. You are expected to pay back the fixed loan in the same amount of time.
Pros
Your interest rate stays the same throughout the loan tenure.
The main benefit of fixed-interest rate financing is that your interest rate remains the same during the loan tenure, even when market prices change.
It helps you plan your budget.
Fixed-interest rate financing allows you to lock in your interest rate as per your ideal budget and plan your other finances accordingly. If you choose to lock in the interest rate, you will know the exact cost of each instalment during the loan tenure.
Cons
Is costlier
Since the interest rate is fixed for the duration of the loan and banks cannot change the interest rate, fixed interest rates tend to be between 1.5% and 2% higher than floating interest rates. This could increase the cost of your overall loan despite the stability of the instalment payments offered by fixed interest rates.
Offer less chance of paying less when interest rates decrease
Even if interest rates drop in the market, borrowers who have chosen a fixed-interest rate regime will still have their EMIs unchanged and will not benefit from any interest rate decreases.
How floating-interest financing works
An adjustable-rate home loan is also known as a floating home loan. It’s a variable interest rate that changes with market conditions due to economic fluctuations.
A floating interest rate is one that changes on a quarterly, semi-annual or yearly basis depending on your loan terms and conditions.
Pros
Is linked to the repo rate
Home loans that are linked to repo rates are directly related to the RBI repo rate.
It applies base pay interest
If you opt for a floating interest rate, you will have to pay the base pay as an additional element to your home loan. The base pay is the minimum interest paid by the lender.
It fluctuates but is cheaper
Because floating interest rates are highly linked to market trends, they tend to change in the short run. However, they are relatively cheaper than a fixed rate.
When the market rates are on the low side, the floating rates are again changed to reduce the loan term instead of monthly payment adjustments.
Cons
Unpredictable nature
Floating interest rates are highly unpredictable, making it hard for borrowers to budget.
It can be inconvenient
There are times when the interest rates would rise to the point where it would be inconvenient for the borrower to pay their EMI.
It may lead to higher premiums
Financial institutions may charge higher premiums when the market is not performing well, impacting the borrower’s pocket.
It can make it difficult to plan finances
With every loan rate change, the EMI could change
Conclusion
When it comes to home loans, there are two main options: fixed and floating. Both have their advantages and disadvantages, so it can be difficult to decide which one is best for you. If you choose the floating option, you will have to pay the base pay interest, which is linked to the RBI repo rate. This is a relatively more cost-effective option compared to a fixed rate in the long run.