While getting a loan may not be very difficult any more, choosing the right option sometimes can be. When one applies for a home loan, the question that often one has to seek an answer to is whether to go for a fixed rate of interest or a floating rate. What actually one looks out is for is a low interest home loan. A home loan wherein the commitment is for the long term, it is often difficult to decide between the two. Is it wise to opt for a fixed rate? Would a floating rate be more beneficial in the long run? Let’s understand the difference between the two, and analyse which works better, and under what conditions.
Fixed versus floating rates
Banks and non-banking financial companies (NBFCs) both offer fixed as well as floating interest rates these days, and it is up to the borrower to decide which they would prefer to opt for. Given that the interest rate is a very critical component of any loan, to understand it in depth before finalising the same is prudent.
When you opt for a fixed rate of interest, the EMIs remain constant over the tenure of the loan. They are not dependent on any changes in the market. During the early part of the loan tenure you wind up paying a large chunk by way of servicing interest while the principal is serviced in the latter parts of the loan tenure.
Contrary to this, when it comes to a floating rate of interest, the EMIs tend to fluctuate, and are dependent on market dynamics, and whether the interest rate decreases or increases. Here, the Prime Lending Rate (PLR) is used as the benchmark for the floating rate, with the interest rate charged to the borrower being the PLR plus a certain spread.
More about fixed interest rates
With a fixed rate, it possibly becomes easier to plan ahead when it comes to your finances, as you are clearly aware of the fixed obligation you have monthly. There is no chance that your monthly commitment will suddenly change with regards to the loan in question.
Also, knowing that a certain fixed amount needs to be paid each month brings with it a sense of comfort and security. There is a certainty that your carefully planned budget will not go askew.
However, if you are to compare rates, a fixed rate is typically higher usually by 1 percent to 2.5 percent in comparison to floating rates. Further, if the interest rates decrease, your loan does not get this added benefit of reduced rates and you as the borrower would need to continue to repay the same amount each time.
When you opt for a fixed rate, do check all details with your lender – sometimes, fixed rates are offered only for a specific period of the loan, for example, ten years of the total home loan tenure of twenty years.
Fixed rates are possibly a better option if the economic scenario hints at an interest rate hike in the near future.
More about floating interest rates
Floating, or variable interest rates being market driven, tend to change with the current market dynamics as implied by the name.
The biggest advantage of floating rates is that they are lower and hence cheaper than fixed rates of interest. This can help you save money over the long run. Let us take an example: If a floating rate is being offered at 12 percent while the fixed is at 14.5 percent, you still save money even if the floating rate rises by 2.5 percentage points.
Further, interest rates typically do not rise over the entire loan tenure, and would be only for a certain period of the loan. Hence even if the floating rate does go higher than the fixed, over the long term it would still bring in significant savings.
What goes against a floating rate is the possibility of a hike in rates that can throw an entire household budget out of gear, as you have to fork out more (all of a sudden) in a particular month towards the EMI.
Where there are pros and cons associated with both types of interest rates, it is up to you as the borrower to determine what suits you best before you sign on the dotted line. Hence, carefully evaluate the options available to you, and do compare across lenders.
Remember that your CIBIL score also plays a critical loan in the entire loan approval process, so it is best to be credit healthy to be able to avail of your loan at the most competitive interest rates. Higher your credit score better are the chances of not only your loan being approved, but you are also more likely to get the best deal. So don't wait anymore, contact a credit health improvement company and improve your CIBIL score today!