With the interest rate on the lower side after the recent repo rate cut to lowest ever of 4% and plethora of offers being rolled out by real estate developers to clear off inventory at some of the places, buying a home at this point in time may come as a big advantage. But most make this big ticket purchase through borrowing route.
So, how and what works well in the long run floating or fixed rate on home loan, here is a deliberation made on the issue:
While the decision on home loan borrowing should not solely be based on interest rate as due consideration needs to be given to other parameters such as processing fees, foreclosure charges etc., your look out at the current juncture when interest rate are at their historic lows can be fixed rate option. And a preference of such an option is seen given the fear of interest rate hike in the distant future when the economy begins to gear up.
What Works well in case of Home Loan: Fixed or Floating Interest Rate Regime?
To enable better transmission of rates to end borrowers, the RBI has asked banks to peg most retail loans to external benchmark rate and there is charged a spread over and above this rate to arrive at the interest rate for a given consumer basis his or her credit profile given the credit risk assessment by the bank.
Now there are two options given to a borrower: fixed and the other is the floating rate
Fixed rate on your borrowing is the rate at which your borrowing gets locked for the entire loan tenure. In such a case the EMI remains the same all through the loan term.
Some Salient Features of Home loan at fixed rate
1. Fixed rate cost is more than the floating rate for the same lender:
Given the fact that banks cannot revise interest rate on such loan type basis the market rate, they usually cover up the interest rate risk by charging a higher rate for the same amount. For the same bank also rates on the two options vary by as much as 250-400 bps, with fixed rate being charged by 2.5-4% more than the floating rate option.
2. Home loan eligibility can be reduced due to higher cost with fixed rate option:
Then as the interest cost or the final liability which is arrived at has to do with the borrower's repayment capacity, higher rate of interest may also put a dent on the higher loan eligibility.
3. Limited option for fixed rate home loans:
There are only a few lenders giving the option currently and that too is way expensive that may not suit your pocket.
4. Prepayment charges on fixed rate:
There is a high prepayment cost of 2% of the outstanding principal amount i.e. charged if you wish to prepay your home loan. But this is not true of floating rate home loans as they do not levy any such charges.
Read the fine-print before taking any call on interest rate on Home Loan
As with the insurance and other investment, taking a wise call on your borrowing will be a wise bet as it comes with a huge cost and not delving in the initial stage could be highly daunting for a borrower.
What needs to be understood here:
There are also home loan options in the market that come with a reset clause that the lender bases on such factors such as the cost of funds and the like. These rates are reset after every some years. Also, based on the pre-specified terms there are also options that convert home loan to floating rate.
Why floating rate can be a better choice?
Here is an illustration from one of the leading portal personal finance webportal:
|Lending institution||Fixed rate home loan||Combination home loan option||Floating rate||Processing fee|
|LIC Housing Finance||Rate fixed for entire tenure at 10.05-10.15%||-||7.4-7.9%||1% Minimum Rs. 10000|
|Axis Bank||Rate fixed for entire tenure at 12%.||-||7.75-11.5%||As applicable at that time|
|HDFC||-||8.2-10.3% ( rate is fixed for 2 years)||7.35-9.6%||Up to 1.5% minimum Rs. 3000|
|IDBI Bank||9.85-10.10% ( rate fixed for up to 10 years)||7.8-9.3%||Up to Rs. 5000|
Floating rate is beneficial as it is more flexible and transparent and gives the borrower to change over lenders if the rate are not competitive for him or her at a cheaper cost. And in a other case, when you see interest rates to rise in the near term you may lock in the current fixed rate that though can be high only in a case if it is for a comparatively shorter tenure.
Also as for most floating rate shall serve well do ensure that it is pegged to EBR or external benchmark rate or not marginal cost of funds or MCLR.