I want to buy a home on loan. Should I take a fixed rate loan or a floating rate loan? Why? – D. Kumar
Loan interest rates play a vital role in the effective management of debt. Under home loans, usually, a borrower gets two interest rate options: fixed rates and floating rates. Sometimes, there may be a third option where the rate is fixed for a part of the tenure and floating for the remaining tenure.
As the name “fixed rate loan” suggests, the interest rate does not change for the full tenure of the loan agreement. For a short duration loan, a fixed rate interest can help the borrower stay protected from interest rate fluctuation. Normally, fixed rate loans are priced higher than floating rate ones. For example, a public sector bank had a fixed rate of 12.05% for loans under Rs. 30 lakh, while its floating rate for the same loan was 8.6%. Therefore the difference between the two rates even with the same lender can be significant.
A fixed rate can be a good choice when the interest rate is expected to increase in the near future. It allows peace of mind to borrowers looking for a constant EMI for the entire loan tenure.
In a floating rate loan, the interest rate will change from time to time with a change in the macroeconomic conditions and with variation in the underlying benchmark interest rate. For a very long duration home loan, a variable rate is a good option. If you are not sure how the interest rate will move in the near future, then it’s better to opt for a floating rate home loan especially if the interest rate is expected to fall. That’s when a floating rate can help you save money. On a fixed rate home loan, you may need to pay a penalty for pre-payments and pre-closures whereas under floating rate loans usually there is no pre-payment penalty levied.
While choosing between fixed and floating interest rate, always evaluate the total cost of borrowing and repayment flexibility to select the right loan instrument.
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