How to Choose the Right Interest Rate for Your Home Loan?

Millions of Indians dream of purchasing a property that they can call their own home. A self-owned home provides a sense of security that no rented house can provide. You can rest assured that come what may, you will always have a house that you and your family can come back to.Nowadays, this dream of owning your home is quickly turning into reality. People from all walks of life are finding themselves capable of buying their own house and realising their dreams. This sense of confidence has been brought about due to the convenience of home loans . A home loan remains one of the most popular and dependable choices if one wants to buy their own home.Having said that, it is not always easy to choose a home loan. There are so many banks and financial institutions out there and all of them have different features for their home loans. Sometimes, it can get taxing when choosing the type of home loan you want to get. One of the major concerns when getting a home loan is the interest rate, as there are a couple of types of interest rates to choose from.So let us take a closer look at the basics of a home loan and understand you can choose a home loan with the right interest rate.

A home loan is a borrowed sum that is lent to you by a bank or a non-banking financial institution that can be used to purchase a house. The borrower, after purchasing the house, then needs to repay the loan amount via Equated Monthly Installments (EMI). This EMI is to be paid every month until the entire loan amount is cleared. The duration of the home loan is called the tenure.

The down payment for a home purchase is the initial amount that you have to pay to the seller. This part cannot be borrowed from a bank or NBFC as a home loan. You can only borrow a certain proportion of the total purchase value of the property.

The interest rate is a percentage of the principal amount borrowed that the borrower has to pay in addition to the principal sum. For example, if you take a home loan of Rs. 30 lakh and the interest rate is 10%, then the total amount that you have to repay is: 30,00,000 + 10% of 30,00,000 = 30,00,000 + 30,000 = 30,30,000/- The interest rate of a home loan is one of the most important factors that you have to consider when choosing a home loan or a lender. Your EMI will have two components, the principal sum component and the interest component. This means that you will be paying a part of the interest in your EMI payments.A high interest rate will significantly increase your repayment amount and thus your EMI. That is why the interest of a loan is so important. It directly increases or decreases the affordability of a loan. A lower interest means you can better repay the loan and vice versa.

1) Fixed Interest Rate

A fixed interest rate on a home loan simply means that the interest rate of the loan will be a fixed amount throughout the tenure. For example, if you get a home loan with an interest rate of 12% and a tenure of 20 years. The 12% interest rate will remain the same for the entire 20 year duration.

2) Floating Interest Rate

A floating interest rate, on the other hand, changes and fluctuates according to the lending rates of the lender. So, your home loan interest rate might be a particular number during one period while another in another period. The fluctuations depend on many factors like RBI policies, rate revisions etc.

3) Semi Fixed interest rate

This is a combined form of interest rate type that keeps the interest rate fixed for the initial duration of the loan tenure, and then the interest rate is changed to a floating type.

There is no straight answer to the question of the best possible type of interest rate. Both fixed and floating interests have their own advantages and disadvantages.Let us take a look at the advantages and disadvantages

Advantages of Fixed Interest Rate:

• You will know beforehand exactly how much interest you’ll be required to pay, since the fixed amount will be the same throughout the tenure.
• Your loan will be protected from interest rate fluctuations because your interest rate was fixed.
• Your money will be saved in the longer run since a high lending rate won’t affect your loan and you will be required to pay the same amount.

Disadvantages of a Fixed Interest Rate:

• The only disadvantage of a fixed interest rate is that, if the lending rate falls, you can’t benefit from the fall since you will have to pay the originally fixed interest rate.

Advantages of a floating interest rate:

• You can make the most of a decrease in interest rate because whenever that happens, your floating rate loan will ensure that you pay less interest.

Disadvantages of a floating interest rate

• If the lending rate goes up, your loan will have to carry the burden because even your interest will go up, leading to higher EMIs.
• It must be noted that a floating interest rate will be usually lower than a fixed interest rate.

You must understand why certain loans attract higher or lower interest rates, or why interest rates for various lenders differ. This has to do with a lot of factors, including your own income, credit score , etc.

1) Income

Your income is important when lenders decide your home loan interest because it gives them an idea about your loan repayment capability. A higher income that is stable will naturally allow the to lower interest rates and vice versa.

2) Credit score

Your credit score is a value that is decided based on your current and previous credit. If you paid your past loans or credit card payments on time, you will have a good credit score. A good credit score will ensure more attractive interest rates and give you the advantage of negotiating a better deal.

3) Property location

If you purchase a property in a prime location or buy from a reputed builder, you can get the advantage of a better interest rate.

4) Loan Amount

The loan amount also has a say in the interest that you’ll have to pay. The higher the loan amount, the lower will be the interest rate and vice versa.

5) Loan Tenure

A longer loan tenure can give you the benefit of a lower interest rate whereas a shorter tenure may attract a higher interest.

6) Type interest

A fixed interest rate will be usually higher than a floating interest rate.

7) Employment type

Lenders usually offer better interest rates to salaried individuals than self-employed ones because of the risk involved with self-employment or business.

In the end, choosing a type of interest, whether fixed, floating or a combination of both, is a matter of personal choice and one’s understanding of interest rate fluctuations. Floating rate of interest is the preferred option among many and hence it is the more popular one opted by a lot of home loan applicants.The thought process behind that is that the floating option gives a chance for the interest rate to come down, thus benefiting you and your home loan. However, that may not be true in all cases.On the other hand, if you have a good understanding of the market dynamics and feel that the interest rates may go up, then you may feel that a fixed interest rate would be the correct decision. Also, if you’re the sort of person that does not like to keep anything to chance, or like to carefully plan your finances, then too, a fixed interest option would be more suitable for you.Like we said, it is entirely dependent on the individual and their personal choices. The only thing that matters is that you consider all factors carefully instead of choosing one because of its popularity. Keep in mind though, that at any time during the loan tenure, you can change your interest type for a small fee. So if you feel you might benefit from one type of interest rate, feel free to convert your home loan accordingly.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.