Floating Home Loan Vs Fixed Home Loan Interest Rate – A guide
Taking a home loan in Chennai is one of the most significant financial burdens people incur. Given the extended repayment period associated with these loans, borrowers are constantly seeking ways to minimise their monthly instalment (EMI) payments. Imagine having to put down such a large percentage of your salary on loan repayments every month for such an extended period of time! Without proper planning, this could significantly negatively affect your financial well-being and mental health. Hence, it is essential to strive for lower home loan interest rates before and after taking out the loan by following some simple guidelines.
This will enable you to pay off the loan more quickly and efficiently without feeling overwhelmed in the process. In this blog, we will help you understand the difference between floating home loan interest and fixed loan interest, this helps to reduce interest rates effectively.
How Does a Fixed Home Loan Interest Work?
When you take out a fixed rate loan, the interest rate stays the same for the entire loan tenure. This means that with a fixed rate home loan, your interest rate will not change even when market rates fluctuate. Fixed rates are usually 1%-2% higher than variable rates, but they come with the benefit of knowing exactly how much your monthly payments will be. However, you may have to pay a prepayment penalty of 2%-4% on the outstanding loan amount should you refinance before the term’s end.
As a homeowner, you may be wondering what interest rate you will pay on your mortgage. It is important to understand that lenders have the right to reset your home loan at any time. This means that your interest rate could change, even though you may have originally signed up for a fixed rate.
When it comes to interest rates, it’s usually best to lock in a good rate when you can. However, sometimes it may make more sense to go with a floating rate instead. This all depends on your personal situation and what you expect interest rates to do in the future. Keep in mind that you can always switch from a fixed rate to a floating rate (or vice versa) at any time during your loan term.
Data for a 2 year time period
- the ideal savings for the fixed method is over 1% annually
- the ideal savings for the floating method is over 3% annually
How does floating home loan interest work?
With a fixed-interest rate home loan, your interest rate will stay the same throughout the life of your loan. However, with a variable or adjustable interest rate, your payments could go up or down based on market fluctuations. This is because the interest rate on your loan is linked to an index, such as the repo rate set by the Reserve Bank of India. For example, when the repo rate goes up, so does the interest rate on your home loan. Conversely, your home loan’s interest rate will also decrease when repo rates fall.
Banks’ adjustable-rate home loans are linked to an external benchmark rate, such as RBI’s repo rate. As the repo rate is RBI’s lending rate to banks and is decided by RBI, it is considered an external rate. Therefore, any repo rate change also affects adjustable-rate home loan interest rates. Under external benchmarks, interest rates are adjusted periodically (quarterly, half-yearly, or annually), depending on loan terms and conditions.
Banks typically charge a spread on top of external benchmarks for housing loans so that you may see variations in the floating interest rates offered by different banks. In Chennai, current floating interest rates for home loans start from 6.50% p.a. and up. Remember that your loan tenure or per month instalment will also change when the variable interest rate changes. Adjustable interest rates may be a good choice for homeowners in Chennai who expect rates to stay the same or decrease over time. On the other hand, floating interest rates may be more suitable for those who are less familiar with the market and prefer to follow prevailing rates.
Data for a 10 year time period
- Fixed method costs you an expensive interest rate for a 10 year time period
- the ideal savings for the floating method is over 4.70% annually
What affects the floating interest rate?
Many factors tend to be deciding the floating interest rates calculation. Some of the most important economic factors are listed below
- Government’s monetary policies
- Repo rate
- Fiscal deficit
- Inflation rate
- Foreign and global interest
When is the ideal situation to opt for floating home loan interest?
A floating interest rate can be a good option in the following situations.
1. When you want to move to a new home in the near future
Adjustable-rate mortgages with a floating interest rate can be a great choice for those who plan on moving after just a few years. This type of mortgage allows you to sell your home and get out of your mortgage before the floating-interest period begins, which can save you money in the long run.
The initial interest rate on your loan is lower than it will be later on. You can take advantage of that now, but be warned: you may not be able to sell your home before the loan’s adjustable period starts.
2. When you plan to invest in housing
Are you thinking of purchasing a starter home? These homes are usually bought with the intention of living in them for only a few years. The idea is to build equity in the property and then sell it at a profit before moving on to a larger home. Taking out a floating interest rate loan could be a good option for you, as long as you don’t plan on staying in your starter home for too long.
3. When the interest rates are high
Mortgage interest rates can fluctuate, so you may want to consider an adjustable-rate mortgage. This type of loan usually starts with a lower interest rate than a fixed-rate mortgage, but it could increase over time. You may be able to refinance your adjustable-rate mortgage when interest rates go down again. Keep in mind that there is some risk involved: Rates could go up instead of down. Also, your home value could decrease, which would make it difficult to refinance.
Benefits of Floating Home Loan Interest Rate
Homeowners should consider a home loan with a variable or adjustable interest rate. These rates are often 1-2% lower than fixed interest rates, and can save you money over the life of your loan. In addition, variable rates may continue to fall in the future, providing even more savings.
2. Edge Over Recession
A recession can be advantageous for those with a floating interest rate. As rates tend to fall during a recession, you will have to pay less money each month on your EMIs.
3. Minimize the Interest Rate
The floating interest rate on your loan can save you money, as the cost of borrowing fluctuates along with the financial market. Investor emotions and decisions significantly impact market rates, which in turn affects the interest rates charged for home loans. So by shopping around and paying attention to the market, you could potentially reduce the amount you pay in interest.
4. No Penalties
When you have a loan at a floating interest rate, you can save money by prepaying the loan without worrying about a prepayment penalty. This is in contrast to a fixed rate of interest, where you would have to pay the penalty for prepaying.