A falling interest rate regime leads to the dilemma for home loan seekers—opt for a fixed rate of interest and lock on to a constant EMI, or go for a floating rate of interest in the hope of further rate cuts?
A falling interest rate regime leads to the dilemma for home loan seekers—opt for a fixed rate of interest and lock on to a constant EMI, or go for a floating rate of interest in the hope of further rate cuts? In recent years, flexi loan—a relatively new entrant on the home loan scene—has muddied the waters even more. There is no clear winner and every type of loan has its own advantages and disadvantages.
Fixed home loan
A fixed rate home loan offers you a loan with a fixed rate of interest. This means that once you enter the loan at a certain rate of interest, it will not change with market fluctuations. Therefore, your home loan EMI stays the same for the full duration of your loan and you can plan your repayments accordingly.
Advantages and disadvantages: The biggest advantage of a fixed interest home loan is that it safeguards you from any further rise in interest rates in future. The bank will not increase your loan interest rate even if their base rate increases over time. The downside is that banks often charge 1-2% more for fixed rate home loans to offset any risk if the rate increases over time. Once you get fixed, you cannot take advantage of any future rate cuts.
Things you should watch out for: A fixed rate home loan may not have a fixed rate for the entire loan tenure. Before opting for a fixed rate home loan, check with your bank the number of years the fixed rate is applicable. Sometimes, banks offer fixed rate loans with the condition that normal floating rates would become applicable for the loan if market rates rise beyond a certain level.
Floating rate home loan
In floating rate loans, the rate of interest is linked to the bank’s base rate. Therefore, any change in the base rate due to various economic conditions will increase or decrease your home loan interest rate.
Advantages and disadvantages: Since floating rate loans are cheaper than fixed rate ones, your monthly EMI becomes more pocket-friendly.
Conversely, floating rate loans can become very expensive if macroeconomic parameters do not support a low interest rate scenario. If the consequent increase is unforeseeably large, this may impact your loan repayment and your monthly personal finances.
Things you should watch out for: Keep a watch on interest rate trends and the macroeconomic parameters. Usually, when inflation is high, banks are forced to increase interest rates. You should not opt for floating interest rates if you expect the interest rates to remain bloated for some time.
Flexi home loan
Flexi home loans are a combination of fixed and floating home loans. Part of your home loan is locked at a fixed rate, with the remaining part under floating rate. This offers you the dual benefit of both fixed and floating rates. You can choose the amount for both fixed and floating parts of loan.
Advantages and disadvantages: Since you can choose the amount under fixed and floating rates, you can hedge your risks against any rising interest rates in future. If the interest rates are climbing, you can foreclose your floating home loan component and opt for a fixed loan plan. If loan interest rates are falling, you can get your fixed rate component converted into floating after paying a conversion fee. On the downside, you can exercise such a conversion only once. Once you choose to convert, it cannot be altered.
Banks charge a fee for conversion between fixed and floating interest rates for flexi loans. The choice between loan schemes depends on your financial plan.
The writer is CEO, BankBazaar.com