Out of fixed or floating interest rate which is better?
This is a dilemma that almost everyone goes through while seeking a home loan. So, how do we choose between a fixed and floating interest rate? The answer may seem a cliché, but it depends on market conditions and your personal choice.Let us analyze which option is better under what conditions.
Fixed vs Floating Interest Rate – A Comparison
|Particular||Fixed Interest Rate||Floating Interest Rate|
|Definition||An interest rate on a loan (eg. home loan) that remains fixed for the entire term of the loan or part of this term.||An interest rate that is allowed to move up and down as per market conditions. Floating interest rate keeps changing during the entire term of the loan.|
|Advantages||1. Interest rate does not depend on market fluctuations.|
2. EMI and loan tenure is fixed for the entire term of the loan.
3. Provides a sense of certainty and security.
|1. Floating interest rates are generally 1-2 percentage points cheaper than fixed interest rates.|
2. In a high interest rate market, floating interest rates are better because you will be directly benefited with any reduction in interest rates.
|Disadvantages||1. Fixed interest rates are costlier. They are generally 1-2 percentage points higher than floating interest rates.|
2. The floating interest rate will not get any benefit of a reduction in interest rates.
3. Sometimes, banks offer fixed interest rates only for initial few years and then convert it into floating interest rate. You should check this with the bank at the time of loan application.
|1. Generally, when interest rates rise, bank will increase your loan tenure without changing your EMI. Your entire financial planning may go haywire. For eg. your loan tenure of 10 years may get increased to 12 years by an increase in floating interest rate.|
2. Another less talked about disadvantage of floating interest rates is that banks will immediately increase your interest rate when rates are rising. While on the other hand when interest rates reduce, you will not be offered the same interest rate that is offered to a new customer.
Finally, fixed or floating interest rate which is better?
Fixed Interest Rate is better, if
- Interest rates are relatively low. It is always better to lock-in at a lower interest rate.
- You are looking for certainty and security. However, this can be a costly option if interest rates are already high.
Floating Interest Rate is better, if
- Interest rates are relatively high and we can expect reduction in interest rates in future. Always compare interest rates before applying for home loan.
- You are looking forward to save money immediately. Imagine a saving of Rs. 10,000 today @ 15% compounding could become Rs. 2 lakh in 20 years.
We hope that now you can decide between fixed and floating interest rate, which is better for your situation.
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