Over the past year, there has been an increase in interest rates attributed to the elevated inflation rate. The surge in interest rates has led borrowers to contemplate the potential switch to a fixed-rate loan. However, it is not as simple as you think.

Both fixed and floating rates have their pros and cons and may be ideal for different situations. However, the shift from a floating to a fixed rate loan involves many factors and can significantly impact your finances. Let’s look at some such factors you must consider before deciding to switch to a fixed rate loan.

Interest rate trends

Interest rates have remained stable following RBI’s decision to keep the repo rate unchanged at 6.5% during the last three monetary policy committee meetings. While the apex bank has been successful in controlling inflation, interest rates may continue to rise in the future depending on economic conditions prevailing domestically and globally.

The anticipation of rising interest rates is, perhaps, one of the primary drivers for borrowers to consider shifting to a fixed-rate home loan. If you believe that interest rates are on an upward trajectory, locking in a fixed-rate loan could protect you from potential increases in the future. Conversely, if interest rates are expected to remain stable or decrease, sticking with a floating rate loan can help lower your overall borrowing costs.

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Financial stability

Fixed-rate loans, with the predictable payments, can be easier to factor in your budget, as opposed to a floating rate loan where payments may differ based on the increase or decrease in interest rates. However, before switching, assess your financial stability and ability to handle fluctuations in your monthly payments. If you prefer a consistent repayment amount, go for a fixed-rate loan.

Loan tenure

Interest rate fluctuations have a stronger impact on longer loan tenures compared to shorter tenures. Considering the uncertainty of interest rate movements in the future, if you are servicing a loan which has a sizeable tenure remaining, a fixed-rate loan may be a better choice for you.

Current interest rate differential

Evaluate the current difference between fixed and floating interest rates being offered by lenders. Sometimes, fixed rates may be significantly higher than floating rates, in which case you must assess whether the stability being offered by the fixed rate loan justifies the potential extra cost of borrowing.

Personal risk tolerance

Your risk tolerance is an important guiding factor when it comes to choosing between a fixed or a floating rate loan. If you’re risk-averse and may find it challenging to manage fluctuations in your monthly loan payments, a fixed-rate loan may bring you greater peace of mind.

Economic factors

The broader economic environment plays an important role in your borrowings. Economic indicators such as inflation, fiscal policies, and global economic trends can impact interest rates and make them swing either way. If prevailing economic conditions suggest a possible volatility in interest rates, a fixed rate loan may be a better option in terms of stability.

Flexibility

Fixed-rate loans typically offer limited flexibility compared to floating-rate loans. This reduced flexibility usually comes in the form of restrictions on prepayment or foreclosure. If you are confident of your ability to repay the loan before its tenure ends, ensure that the fixed-rate option doesn’t impose penalties that could negate the benefits of prepayment.

The interest rate fluctuations announced in the last year have significantly impacted borrowers, in light of which, fixed rate loans, with their predictability and stability, may be a suitable option for borrowers averse to risk. However, the right timing to shift to a fixed rate loan requires striking a balance between financial security and the cost it may come at. It is, thus, crucial that you analyse your present and future financial situation, stay informed about the economic landscape, and assess the long-term implications of your decision, should you plan to switch.

(The author is CEO, Bankbazaar.com. Views are personal)