Whether to choose a fixed rate home loan, which is easy to budget and has an element of certainty with it or to choose a floating rate of interest that provides the benefits of decreased interest rate, is a classic dilemma that has perplexed home loan seekers for ages. Here we take a look at the benefits and drawbacks of both the fixed and floating rate home loans.
Fixed interest rate home loans
As the name implies, fixed interest rate home loans allow the repayment in fixed equal monthly installments over the entire period of the loan. The interest rates in such a case is fixed and doesn't change with market fluctuations. During the early part of loan tenure the majority of monthly payments are used to service the interest and principal is served in the later parts of loan tenure.
Benefits of fixed rate home loans
The benefit of such loans is that because the interest rate is fixed, even if the market pressures push the interest rates to high levels, the borrower pays a fixed Equated Monthly Installment (EMI). A fixed rate home loan is excellent for those who are good at budgeting and want a fixed monthly repayment schedule, which is easy to budget and doesn't fluctuate. Thus fixed rate home loan brings a sense of certainty and security.
Drawbacks of fixed rate home loans
The major drawback with fixed rate is that it is usually 1 - 2.5% more than the floating rate home loan. Secondly, if for any reason the interest rate decreases, the fixed rate home loan doesn't get the benefit of reduced rates and the borrower has to repay the same amount every time. Another area of concern is whether the fixed rate home loan is 'truly fixed' or fixed for just few years. This has to be ascertained while taking the home loan. A 'fixed' home loan, which can be changed every few years will definitely wipe out the very spirit of such a loan. Experts agree on the fact the fixed rate are a better option if the economic scenario promises a rise in interest rates in near future.
Floating rate home loan
Floating interest rate home loans are tied up to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies.
Benefits of floating interest rate home loan
The biggest benefit with floating rate home loans is that they are at least 1%-2% cheaper than fixed interest rates. So, if you are getting a floating interest rate of 11.5% while, the fixed loan is being offered at 14%, you still save money if the floating interest rate rises by up to 2.5%.
Even if the floating rate goes over the fixed rate, it will be for some period of the loan not for the entire tenure. The interest rates will surely fall over a long period and thus floating interest rate brings a lot of savings.
Drawbacks of floating interest rate home loan
The drawback with floating interest rate is the uneven nature of monthly installments. This makes it difficult to budget with floating interest rate home loans. As seen in recent times due to the hike in floating home loan interest rates, the borrowers had to shell out thousands per month extra as their EMI's, throwing their entire budget out of order.
When it comes choosing the interest rate regime, majority of home loan borrowers, in fact over 90% of them go for a floating interest rate home loan. Finally, it is up to the borrower to decide on what suits him the best. Ideally the borrower should compare home loans for various parameters and understand every single detail about it. If certainty and security are prime consderations, a fixed rate home loan will be the best, however it won't come without the premium on interest rates.