The tax incentive on housing loans makes it a very viable and popular option amongst buyers for purchasing residential properties. Once the house has been decided on, then the next step is to look at the options available for financing the purchase.
A buyer would prefer to finance the maximum part of his purchase through a home loan, keeping in mind his ability to repay the loan amount on time. There are two ways available for taking a home loan- a fixed rate loan or a floating rate loan.
Before deciding on either of the options it is important to understand the basic differences between these two options, as they make a substantial difference to the cost of borrowing.
In case of a floating rate of interest, the interest rate is directly proportional to the prime lending rate of the bank (PLR), commonly known as the benchmark. Thus any variation in the PLR would cause the interest rate to vary accordingly. The banks generally review and revise their PLR on quarterly or half yearly basis.
The recent trend of falling interest rates makes this the most preferred option amongst borrowers. But if the borrower opts for fixed rate loan, in the times of falling interest rate, it would pose as a major disadvantage to him.
Fixed interest rate on loans is an option where the interest rate is the same through out the loan repayment period. The major advantage of this option is that the borrower is shielded from any increase in the rate of interest in the market.
Every bank formulates its own strategies for fixing the interest rates. Due to a non stardardised definition of fixed interest rate and floating interest rate in the market, every bank uses its own parameters to define these terms. Thus it becomes important for the borrower to analyse all the aspects of the proposal of the lender before taking the final decision.
At times the banks fix the interest rates in fixed rate loan only for a certain initial period of time of the repayment period. Once that period is over (for example, at the end of five years) the fixed interest rate is modified according to the present PLR.
Most of the times the banks fix the interest rates with the condition attached that the PLR should remain within a certain range. The rise of PLR above the upper limit of the range causes an upward shift in the fixed interest rate. In both these cases the fixed interest rate ceases to remain fixed as suggested by the definition.
Nowadays the borrowers have an altogether third option available in the market – split rate loan. In this case a part of the loan amount is subjected to fixed interest rate and the other part to floating interest rate. The option gives the borrower the advantages of both fixed as well the floating rate loan. Each bank has its own policies regarding the division of loan amount into fixed rate loan and floating rate loan.
The final choice from the options available in the market would depend upon various factors including the borrower's risk taking ability and his perception about the long term interest rate.