Which is better? Floating or fixed rate home loan
Premium- Borrowers who have opted for fixed rate on their home loans don’t benefit from the falling interest rates
Last week, the Reserve Bank of India (RBI) raised the repo rate by another 50 basis points (one bps is one-hundredth of a percentage point). This was the second rate hike in less than a month and market experts expect the rates to rise further.
Rising interest rates have brought back the focus on fixed rate home loans as loans are getting costlier with rate hikes.
Loans offered at fixed interest rates have a predetermined EMI that remains steady through the loan tenure. This is in contrast to loans with floating rates, which are linked to an external benchmark and are revised every quarter depending on economic factors.
A big advantage of fixed EMIs is that the borrower knows exactly what they will pay through the loan tenure and the EMIs and, in turn, their monthly budget will remain unaffected amid a rising interest rate regime. But, is predictable cash flow a good enough parameter to opt for a fixed rate home loan over a floating rate loan?
Fixed rate loans typically carry a higher interest rate compared to floating rate loans, say experts.
“The disadvantage with fixed interest rate schemes is that they attract pre-payment penalties and are priced at higher rates of interest," said Raj Khosla, managing director, MyMoneyMantra.com.
Banks offer a higher rate on a fixed rate loan compared to a floating rate loan in a rising rate regime so that they can earn more on the latter when the rates increase. Interest on fixed rate loans could be as high as 300-350 bps than floating rate loans.
Also, borrowers with fixed rate loans don’t benefit from falling interest rates either, as was the case in the last 40-48 months.
Currently, there aren’t too many fixed rate home loan products available in the market, but banks are expected to launch a few schemes soon, as per Khosla.
“When it is offered, borrowers are advised to avail of a semi-fixed interest rate scheme. There is of dual advantage, i.e., customers can choose a fixed rate of interest for the first two years, during which interest rates are expected to remain high; and then move to a variable interest rate thereafter," he said.
If borrowers with floating rate loans are planning to switch to fixed rates, they should do so only if the fixed rate being offered is not more than 200 bps higher than the current rate on their floating loan.
“If a borrower has only 2-3 years left on their loan repayment and they are getting a fixed rate 100-150 bps expensive than the floating rate, they should switch to fixed rate as interest rates are expected to increase by more than 150 bps over the next one year or more," said Amit Suri, an MF distributor.