Understanding Interest Rates: Fixed vs. Semi-Fixed vs. Floating

While narrowing down on a financer, the home loan rate of interest is one of the key considerations for a fence-sitting homeowner. Most potential borrowers put considerable weightage on the rate of interest before selecting a financer. Well, the reason is not hard to understand since the rate of interest is directly associated with the monthly EMIs.

However, as a borrower, you must know about the types of Home Loan interest rates available. Each of them is different, and not every type is suitable for everyone. The three most common types of home loan rates of interest are - fixed, floating, and semi-fixed.

Also Read: Is Interest Rate Everything in Home Loans?

WHAT IS A FIXED HOME LOAN INTEREST RATE?

As the name suggests, in a fixed home loan interest rate, the rate of interest is fixed throughout the loan tenure. Once locked, the interest rate remains the same until the time you repay the loan. Irrespective of the market happenings, the rate of interest remains constant.

For example, imagine securing a 20-year fixed-rate mortgage at 8%. Your monthly payment remains constant, say ₹10,000, regardless of fluctuations in the market. This stability can be particularly advantageous for individuals who dislike uncertainties and prefer a structured approach to managing their finances.

Pros of Fixed Home Loan Interest Rates

• Immune to market events and decisions taken by RBI on crucial policy rates, such as repo rate. The rate of interest remains the same until you repay the loan, and that is one of the biggest advantages of a fixed home loan interest rate.

• Helps plan cash outflow and budget since you know much EMI you need to pay each month. Once you have factored in the EMI, you can direct money towards addressing other expenses, providing stability in overall finances, especially instalment payments

• Ensures financial security for borrowers since they need not expect any future risks as the interest rates remain the same.

Cons of Fixed Home Loan Interest Rates

• Is expensive, and stability and predictability in EMI provided by fixed home loan interest rates come at a cost. These interest rates are a little higher than floating, making them costlier.

• No benefit from the fall in rates. In other words, the lender will not be able to pass the benefits of reduced rates to you. Your EMIs wouldn’t change despite a fall in rates.

• Prepayment penalty. If you wish to pre-pay a loan, availed on a fixed interest rate, you may need to pay a penalty. However, the amount varies across lenders and depends on the terms and conditions of the loan.

Ideal situation to opt for a home loan on a fixed interest rate

If you don’t want your EMIs to be unpredictable, it makes sense to opt for a home loan at fixed interest rates. Also, if there are chances of rates going up, you can avail of a home loan at a fixed rate of interest.

WHAT IS A FLOATING HOME LOAN INTEREST RATE?

Floating interest rate, unlike fixed rates, keeps changing as per the prevailing market conditions. It can go up or down depending on the situation. Floating interest rate is made of two parts – benchmark rate or index and spread. The benchmark rate is the measure of interest rate, while the spread is the extra amount lenders add to cover credit risk, profit mark-up., etc.

The spread amount differs across lenders. However, it remains constant throughout the loan tenure. On the other hand, if index rates move up, you need to pay a higher EMI and vice-versa.

Let's illustrate this with a car loan. You opt for a floating-rate loan with an initial rate of 7%. If the repo rate rises, your monthly payment could increase, potentially straining your budget. Conversely, if the repo rate decreases, your payment could decrease, offering some financial relief.

Pros of Floating Home Loan Interest Rates

• Cost-effective in the long run since it is linked to the repo rate (the rate at which financial institutions borrow from the RBI). When repo rates go high, as they have now with the RBI increasing it by 40bps to 4.40%, floating rates would go up and vice versa. Note that while banks need to choose a benchmark rate such as the Repo rate for deciding Home Loan interest rates, housing finance companies (HFCs) and non- banking finance companies (NBFCs) can determine their own rates.

• No pre-payment penalty as the RBI has banned penalties on home loans availed on floating interest rates. It means if you want to close the loan before its tenure by making pre-payments, no penalties will be levied.

Cons of Floating Home Loan Interest Rate

• Is unpredictable since factors affecting markets are beyond control and depend on domestic and international forces. The culmination of all these makes floating rates a little erratic.

• Makes it difficult to plan finances as the EMIs could potentially change in case key policy rates change.

Following RBI’s hike in repo rates, several lending institutions have revised their home loan rates and have sent communication regarding new rates of interest to customers.

“I received a mail intimating me about the hike in EMIs of my loan from my lender. The rate of interest has been hiked from 6.75% earlier to 7.15% on my INR 30 lakh loan for a tenure of 20 years. It has made the EMI dearer by INR 719. I now need to save more,” says Arup Choudhury, a working professional in Kolkata.

Ideal situation to opt for a home loan on a floating interest rate

Ideally, you should opt for a home loan on floating interest rates when your income flow is adequate, and you are prepared mentally for a change in EMIs midway. If you are comfortable during periods of unpredictability, you can go ahead and opt for a home loan on a floating rate of interest.

WHAT IS A SEMI-FIXED HOME LOAN INTEREST RATE?

A semi-fixed home loan interest rate combines fixed and floating rates. Here, the home loan rate of interest is fixed for a specific period, after which, it’s converted into a floating one. It means in the initial years, the rate of interest is fixed. After some years, it automatically converts into a floating rate of interest.

Imagine a 5-year home loan with a 5% fixed rate for the first five years, followed by a floating rate. This structure provides initial stability and budgeting ease during the early years, allowing you to plan your finances effectively.

Pros of Semi-fixed Home Loan Interest Rates

• Gives you the best of both as a borrower can avail the advantages of fixed and floating interest rates.

• Flexibility on offer gives you time to prepare finances to align the EMIs as per the floating basis. Once the EMIs convert into the floating regime, you are better prepared to handle unpredictability.

Also Read: What Are Semi-Fixed Home Loans? A Simple Explanation

Cons of Semi-fixed Home Loan Interest Rates

• Can make switching from fixed to floating difficult, especially once you get accustomed to the fixed obligations. If not prepared well, things can quickly go out of hands.

• Your EMIs can significantly jump if there’s a rise in interest rates during the fixed period. As you enter the floating regime, the same will push up your EMIs by several notches.

Ideal situation to opt for a home loan semi-fixed rate

If there are chances of rates going high and then coming down, it makes sense to opt for a home loan under semi-fixed rates. If you have a medium-term home loan tenure, it’s wise to go for semi-fixed rates.

The table below captures the key differences between these three rates on different parameters:

Beyond the Basics: Additional Resources

Understanding different interest rate options is crucial, but it's not the only step in your borrowing journey. Effective financial planning and well-informed decision making is key to meeting your financial goals.

One of the ways you can plan your EMI payments is by using –

Interest Rate Calculators: Online loan EMI calculators help you estimate your monthly payments. Mainly, you can compare different interest rate options based on various loan amounts and tenures. It allows you to better understand the impact of interest rates on your repayments.

Also Read: How EMI Calculators Simplify Loan Evaluation and Budget Planning?

Conclusion

Now that you know the various types of home loan interest rates, opt for the one basis your income and risk tolerance. As rate of interest profoundly influences EMIs and plays a crucial role in effectively First, let’s understand the managing the Home Loan opt for the one that doesn’t pinch your pocket hard.

Ready to take the next step? Apply now for a loan today and turn your financial aspirations into reality.

Disclaimer:

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