A fixed rate loan gives a sense of security and certainty, but borrowers may lose out if rates dip.
With news about banks cutting interest rates regularly hitting the headlines recently, home loan borrowers are in a dilemma — whether to switch to a fixed rate loan at the current rates or to continue to float at market rates. A fixed rate naturally affords a sense of security and certainty, especially when it comes to long-term commitments like home loans. Yet, it comes at a cost — if rates dip further, you would have locked yourself on to a higher rate.
Rate fluctuations in the past
Opting for a fixed rate loan may sound like the sensible thing to do, if only to insulate oneself from market fluctuations, except that there is an element of uncertainty with respect to the direction lending rates may take moving forward. From the 7-8% range in the mid-2000s, rates had shot up to 12-13% in 2009-10, with a trend reversal now emerging in the current year. In such a scenario, deciding whether to opt for a fixed rate loan is not an easy decision.
Moreover, a home loan is a long-term commitment, so even if expert predictions paint the scenario a year or two ahead, this may have little bearing on your overall loan interest, considering you have 10-20 years of repayment ahead of you. Here are a few considerations to keep in mind while taking that all-important decision.
When to go for a fixed rate loan
You are comfortable with your current EMI: If your current EMI is less than 35-40% of your monthly income, you will likely find repaying your loan not a hassle. You can consider fixing your rate at this level to avoid future possible hikes, which may disturb your finances.
You want certainty in the initial period of the loan: Given your other financial commitments, if you cannot afford any further rate hikes for the next few years at any cost, then a part-fixed-part-floating-rate loan offering a fixed rate for the first 3-5 years and a floating rate thereafter is for you.
You expect interest rate to increase shortly: If you perceive market conditions are such that rates are only going to increase — however unlikely that may be currently — you should choose a fixed rate.
You don’t expect to prepay the loan: If you are not looking to prepay the home loan and service it for a long tenure, it is always good to choose a fixed rate when the rates come down. This may help you to reduce the interest outflow for the long term if you are getting a good rate under a fixed loan.
When not to go for a fixed rate loan
You are planning to prepay the loan: If you plan to make part pre-payments every year or close the loan within 5-7 years, you can continue with a floating rate. This is because, the earlier you close the loan, the lesser is the interest outflow. Consequently, rate fluctuations have a lesser impact on your loan on a whole.
You can manage rate fluctuations: If you can manage your EMIs despite the fluctuating rates, you need not opt for a fixed rate. This applies when your EMI is less than 35% of your salary. Since fixed rates are often higher than prevalent floating rates, you may find it difficult to manage a fixed rate loan in such cases.
Your loan is likely to end within 10 years: If your loan is likely to end within 10 years, or if you have opted for a short duration loan, you need not opt for a fixed rate. For short duration loans, the interest outflow is lesser. Also, as your loan advances in tenure, your EMI will increasingly feed the principal component, diminishing the effect of fluctuating rates on the interest component.
You expect the rates to dip: If you expect interest rates to come down further in the current scenario, it is better to wait and watch with a floating rate. You may get a better fixed rate deal later when banks turn competitive in a downward trend.
Keep in mind that all fixed loans are not fixed and usually there is a fee for switching from floating to fixed rates.
Also, it may be a good decision to switch to fixed if the rates are in single digits or if the difference between floating and fixed rates is 1% or more. In short, there is no definitive answer to the fixed rate riddle. A lot depends on your preference and financial standing.
* Opting for a fixed rate loan may sound like the sensible thing to do, except that there is an element of uncertainty over the direction lending rates may take moving forward
* From the 7-8% range in the mid-2000s, rates had shot up to 12-13% in 2009-10, with a trend reversal now emerging in the current year
* Moreover, a home loan is a long-term commitment, so even if expert predictions paint the scenario a year or two ahead, this may have little bearing on your overall loan interest
* It may be a good decision to switch to fixed if the rates are in single digits or if the difference between floating and fixed rates is 1% or more
* All fixed loans are not fixed and usually there is a fee for switching from floating to fixed rates
* Also, a lot depends on the borrowers’ preference and financial standing while opting for a fixed rate loan
The writer is CEO, BankBazaar.com