Fixed vs Floating Interest Rate: Which is Better for Home Loan?

The first thing we consider while deciding whether or not to buy something is its price. While buying clothes, you would compare the prices from different stores. While hiring an accountant to file your tax returns, you would compare their hourly rates.Similarly, you would compare interest rates when deciding which home loan to take. Interest rates are in two forms - floating interest rates and fixed interest rates. Not knowing the difference can make it difficult to make the right decision.Overlooking the difference of even a 0.5% interest rate can cost you a fortune over the tenure of the Home Loan.This article compares fixed interest rates versus floating interest rate Home Loans. It will help you identify which type of interest rate would be cheaper in your case.If you are new to Home Loans, look at this article simultaneously to refer to the meaning of any terminology that might appear in the article.Also read: How To Calculate EMI For Home Loan

In fixed-interest rate Home Loans, the rate of interest charged remains the same throughout the tenure of the loan. There are no changes in the interest rate, no matter what the changes in the market interest rate would be.It makes it easy for you to plan your financial journey as the Home Loan EMIs, a big expense, will not change for the whole tenure (which can range from 5 to 30 years). Planning your monthly budget and investment journey becomes very simple if the tenure of your Home Loan and its EMI are predictable.Nowadays, you can also opt for Home Loans with fixed interest rates for 2 to 10 years and floating interest rates for the rest of the tenure.In India, fixed interest rate loans are offered by banks and NBFCs, typically with an interest rate higher than that of floating interest rate loans. If the difference between fixed and floating interest rates is very high or if your loan’s tenure is on the high side, it becomes important for you to recognise which is cheaper.

Fixed interest rates - Pros & Cons

Pros

• Certainty regarding interest expenses
• Market changes do not affect the interest rate
• Easy to plan around

Cons

• Interest expenses will stay high even when the market interest rate decreases as the loan's interest rate remains unchanged.

Also read: What is Retail Prime Lending Rate for Home Loan?

The floating interest rate system has the characteristic of changing interest rates with market conditions. Every lender sets a benchmark rate that syncs with the market interest rate. The floating interest rate on Home Loans moves along with the benchmark rate.Lenders reset benchmark rates periodically. Some lenders might choose to change the benchmark rate every quarter, every six months or every year. Some lenders might choose to reset the benchmark rates on Home Loan anniversaries.You should note that lenders can change their interest rate reset cycles.When the benchmark rates increase, your Home Loan interest rate will also increase if you have chosen a floating interest rate Home Loan. On the other hand, when benchmark rates fall, your Home Loan interest rate will also fall if you have chosen a floating interest rate Home Loan.When the interest rate on your Home Loan changes and your tenure remains the same, your EMIs will change. It can be difficult to deal with if interest rates and EMIs increase. The lender may let you choose to expand the loan tenure with minimal changes in the EMI.

Floating interest rates - Pros & Cons

Pros

• Interest expenses will drop when market interest rate drops
• Typically, floating interest loans are offered at interest rates 1% to 2% lower than fixed interest rates

Cons

• EMIs will change with changes in market interest rate
• Difficult to plan your expenses around
• No fixed payback timeline

Also read: What is Home Loan Provisional Certificate?

When comparing fixed versus floating interest rate Home Loans, you should note that the long tenure of a Home Loan can cause wide differences in EMIs. The term of a Home Loan can go as high as 30 years, whereas the tenure of a Personal Loan goes up to only seven years. With a short tenure, you might not expect the interest rates to change too much.We can see this through historical repo rates, the rate at which RBI lends to banks. It affects interest rates on all loans. For instance, over the last five years, the repo rate has been between 4% to 6.5% . But, in 2000, the repo rate was as high as 16% .If you took out a Home Loan in 2000 with a tenure of 30 years at a fixed interest rate, you would be paying more than 16% for 30 years. But, if you had chosen a floating interest rate, your interest rate would have dropped by nearly 9.5%, which is the difference between the current repo rate ( 6.5% ) and the repo rate in August 2000.If you consider the current interest rate high and expect it to fall over the next few years, it is wise to opt for a floating one.Even if interest rates were to stay constant for the entire home tenure, a floating interest rate loan would be the better choice as it offered a lower interest rate than fixed interest rate loans.Fixed interest rates are the better choice only when you expect interest rates to rise higher than the difference between floating and fixed interest rates.Also read: Everything about the Base Rate in a Home Loan

For short-term borrowers, floating interest rate loans might be better as they have a lower interest rate of 1% to 2%, and the floating interest rate is unlikely to overtake the fixed interest rate in the short term.Long-term borrowers will need to consider if the market interest rate is high or low and whether it will drop or rise in the future. During economic recessions, interest rates are low, and during economic booms, interest rates are high.You can also make a decision based on your preference. If you prefer to know exactly how much EMI you owe monthly, fixed-interest-rate loans might be best for you.