Fixed vs Floating Interest Rate – Which Is Better for Home Loans?

Buying a home is one of the most significant milestones in your life. People save hard-earned money for decades to realise their dreams of owning a home. It is a financial decision that will determine the future of generations to come. Hence, it is not a decision to make without careful planning. Home loans are the easiest way you can procure your own house. First-time buyers must understand the nuances of applying for a home loan such as home loan interest rate and what fixed interest rate and a floating interest rate mean. Here we will break down their pros and cons to help you decide which one works best for you. 

Choosing between a fixed interest rate and a floating interest rate depends on various factors – real estate market conditions, your financial capability and the risks involved. 

What is a Fixed Interest Rate?

A fixed interest rate means that the rate of interest decided upon at the time of signing your loan agreement will remain the same throughout the tenure of your loan, irrespective of the fluctuations in the market. 

Some of the advantages of Fixed interest rates are- 

1. Predictability: There aren’t any surprises as far as your monthly EMI is concerned as the rate of interest remains unchanged. This makes it easier for you to plan your finances. 
   
   
2. Protection from Rate Hikes: Since the Interest rate is fixed, you don’t get to face any hike in the home loan interest rate caused by volatility in the market.
   
   
3. Long-Term Stability: A fixed interest rate is a boon for those who depend on their monthly salary for livelihood. It offers peace of mind knowing there won’t be any changes in the EMI. 

Fixed-rate of interest also has certain disadvantages- 

• Higher Initial Rates: Fixed rates are usually slightly higher as compared to floating rates at the time of loan approval.
  
  
• Lack of Flexibility: In case there is a fall in the home loan interest rate, you will not get access to that.
  
  
• Prepayment Charges: If at some point you wish to pay the loan amount before the tenure ends, some banks may levy charges. 

What is a Floating Interest Rate?

A floating interest rate, also known as a variable rate, means that your home loan interest rate may increase or decrease depending on the changes in the benchmark rates set by the Reserve Bank of India. This means that your monthly EMI is also subject to change accordingly. 

The advantages of floating interest rate are- 

1. Lower Initial Rate: Usually, the floating rate is lower than the fixed rate of interest at the time of signing the loan agreement, reducing your monthly EMI considerably.
   
   
2. Benefit from Market Drops: The biggest advantage of a floating interest rate is that if and when the market trends downwards, your EMI reduces significantly. 
   
   
3. No Prepayment Penalty: For a floating interest rate, most banks do not levy any charges for the prepayment of loans. 

Disadvantages of floating interest rates- 

1. Unpredictable EMIs: The biggest disadvantage of floating interest rates is that the changing interest rates can throw your monthly budget off due to unpredictability.
   
   
2. Market-Driven: Your EMI amount is completely dependent on the changing monetary policies which can be unnerving.
   
   
3. Risk of Increase: If the interest rates go up, your EMI can go considerably higher, which can result in more financial burden. 

Fixed vs Floating – Which is Better?

Now coming to the big question- which is better? Fixed interest rate or Floating interest rate? The truth is that both have their pros and cons and risks involved. 

Choose Fixed Interest Rate if:

• You are looking at financial predictability and stability.
• You have been advised that interest rates are likely to rise soon.
• Your monthly income does not allow you to take the risk of increasing interest rates and you are looking for consistency. 

Choose Floating Interest Rate if:

• You are willing to take risks for potential savings.
• You believe the interest rate market will either fall or remain stable.
• You know you can pay the loan off early or within 3-5 years. 

In a nutshell, both flexible interest rates and floating interest rates have benefits and disadvantages depending on your financial situation, your ability to take risks and your understanding of the market and market conditions.

It is advisable to consult a financial expert or speak with multiple loan lenders to compare the rates of interest, to help you balance your finances. A home loan interest rate determines your comfort in repaying the loan for your dream home. 

Frequently Asked Questions (FAQs)

Q1. Can I switch from a fixed interest rate to a floating interest rate during my loan tenure?

Yes, many banks and financial institutions offer the option to switch between fixed and floating interest rates during the loan tenure. However, this may involve a conversion fee or administrative charges. Always read the terms and consult your lender.

Q2. Is a fixed interest rate better for long-term home loans?

Fixed interest rates offer stability and predictability, which can be helpful for long-term financial planning. However, they may be slightly higher than floating rates initially. If you prioritize consistent EMIs, a fixed rate could be a better option for a long-term loan.

Q3. Are floating interest rates risky?

Floating interest rates fluctuate with market conditions, so they carry some risk. If interest rates rise, your EMIs may increase. However, if rates drop or remain stable, you could benefit from lower payments. It’s best suited for borrowers who can absorb short-term rate fluctuations.

Q4. How does the Reserve Bank of India (RBI) affect floating interest rates?

Floating rates are directly linked to the RBI’s benchmark rates (like the repo rate). When the RBI reduces these rates, banks often lower their lending rates, which benefits borrowers with floating rate loans. Conversely, an increase by the RBI can raise your EMI.