Fixed Vs Floating Interest Rate

Each one of us desires to own a house and turning this dream into reality requires some efforts as one should be aware of certain terminologies before reaching to a borrower for a home loan. Through his article we would elaborate different kinds of interest rates on home loan and focus would be on two major categories i.e fixed and floating rate of interest.

Fixed Rate of Interest Meaning

As the name suggests, fixed interest rate is the rate of interest which remains fixed over the entire period of loan. In case of home loan, it implies that equated monthly installments remains fixed throughout the tenure of home loan. As the interest remains fixed it does not change with market fluctuations. Majority of the Initial payments are towards interest servicing and payments towards principal is in the later part of loan.

Some of the loans especially offered with fixed rate of interest on home loans may not be fixed in true sense as the fixed rate of interest might be for only few years and after some years rate of interest might change and accordingly we have another category for rate of interest

Resettable Fixed Rate of Interest

Most of the lenders offering fixed rate of interest, offer this product wherein the interest rate remains fixed for a particular duration say suppose 3 or 5 years and after that period rate of interest  gets reset once again

Floating Interest Rate Meaning

Floating rate of interest is also known as adjustable, flexible or variable rate of interest. Unlike fixed rate, interest rate keeps changing with the fluctuations in market and it is according to market lending rate. It is composed of base rate so if the base rate varies, floating rate of interest also varies. Fluctuation of interest rates in turn lead to change in EMI amount or change in tenure.

Example:-Mr. Kumar takes a home loan for 20 years for Rs.20,00,000 with a rate of interest as 10% , then EMI comes out to be Rs.19, 300. However if the rate of interest increases to 11% after a period of 2 years, the new EMI becomes Rs.20559

Fixed Cum Floating Rate of Interest

These loans are also called as partly fixed and partly floating interest rate, split rate or dual rate loans. Some of the lenders offer fixed rate of interest for initial few years and later rate of interest gets automatically converted to retail prime lending rate(RPLR)

Example:-HDFC was recently offering2 schemes:

• a rate of 10.75% for a loan upto Rs.30 lakhs and this fix rate would be available upto 30^th November 2014 or
• a rate of 11.25% for a loan upto Rs. 30 lakhs and this rate would remain fix till 30^th November 2016

After that rate of interest applicable will be RPLR. Also some lenders give an option to borrowers to decide the ratio (half, quarter or three quarters) of the loan amount in between fixed and floating rate of interests.

Advantages of Fixed rate of Interest

• Since the interest rate is fixed so even if the market fluctuation increases the rate of interest, the person ends up paying the same equated monthly installments.
• It brings a sense of certainty and security.
• It is beneficial for those who want fixed monthly repayment schedule as it doesn`t fluctuate.
• One can select this option of interest rate if the current interest rates are below the average of historical interest rates in India.

Disadvantages of Fixed Rate of Interest

• The fixed rate of interest is 1-2.5 % higher than floating rate of interest.
• Also banks charge 2-5 % prepayment penalty on fixed interest as these carry risk of interest rate changes.
• Another disadvantage with fixed rate of interest is that if the market rates fall, the borrower will continue to pay the same amount without any benefit of interest rate reduction

Advantages and Disadvantages of Resettable Fixed rate of Interest

The advantages and disadvantages remain more or less the same like fixed rate of interest but these have an upper hand over floating rate of interest as it gives more control and assurance of the EMI amount.

Advantages of Floating Interest Rate

• The main benefit is that floating rates of interest are cheaper when compared to fixed rate of interests.
• Another benefit is that banks cannot charge prepayment penalty charge on floating rate of interests as per guideline from RBI.
• It offers transparent rate of interest as the interest rate increases or decreases with the general interest rates.

Disadvantages of Floating Rate of Interest

• The biggest drawback is the uneven nature of monthly installments.
• Due to increase in floating interest rates borrowers have to spend extra for monthly EMI`s.

 Advantages and Disadvantages of Fixed cum Floating Rate of Interest

These interest rates offer the advantage of diversification as it provides fixed rate of interest for some duration and floating interest for other duration. These are helpful when the interest rates are expected to rise in future.

Similarly we also have fixed and floating interest rate on fixed deposits as well, the later ones are called floating rate term deposits where the interest rate on fixed deposit changes with the change in the base rate of the bank interest rates

Conclusion

It has been observed that most of the borrowers choose floating rate of interest but still the option rests with the borrower as to which parameter is given due importance. In case of security being prime factor, fixed rate of interest is considered over floating rate of interest. Also its advisable that the borrower reads all terms and conditions mentioned in the loan agreement to understand all the details well in advance

Post Your Comments: Do post your valuable comments and let us know if you have taken fixed or floating rate of interest