What works for your home financing? – Advisor Forbes INDIA
Financing a home can be a tedious and time-consuming process for homebuyers. To make an ideal choice, it is important to know the type of interest rate plan that meets your needs.
Your two financing options are the fixed interest rate and the variable interest rate. Here’s what you need to know about them.
How Fixed Rate Financing Works
As the name suggests, a fixed interest rate means that the rate you are charged will remain the same for the duration of the loan, regardless of any changes in market rates. You are expected to repay the fixed loan in equal amounts of installments over time.
- Remains constant throughout the mandate
The main feature of fixed interest rate financing is that your rate stays the same even when market prices fluctuate, which happens when the central banking authority – the Reserve Bank of India – changes the rate at which banks can borrow and lend.
- Helps you plan your budget
In a fixed interest rate scenario, borrowers can lock in the interest rate according to their ideal budget and plan other finances. If you opt for this interest rate, you will know exactly how much each payment will cost during the term of the loan.
Fixed rate home loans are easy to understand and vary little from lender to lender. They can be an ideal choice for those who plan their budget diligently, as this rate requires you to pay the same amount of monthly installments (EMI) from year to year throughout the life of the loan.
Since the rate is constant throughout the term and banks cannot revise interest rates, fixed interest rates are typically 1.5% to 2% higher than the interest rate variable. This could make your overall loan more expensive despite the stability of installment payments it can offer.
- Offer less chance to pay less when rates go down
Even if the interest rate drops in the market, for those who have opted for a fixed interest rate plan, their EMIs will remain unchanged and they will not be able to benefit from any rate cuts.
- Is hard to get when rates are high
If interest rates are high, it becomes difficult to qualify for a loan due to the need to make higher payments.
Some fixed rate loans may only remain fixed for certain periods.
Depending on the term of your home loan, there may be instances where your fixed interest rate is only applicable for a few years after it automatically converts to a variable interest rate loan. In such cases, the fixed rate interest could be revised, affecting the current long-term payment rate.
It is therefore crucial to read the agreement carefully to know the exact terms of your loan.
How Variable Interest Financing Works
They are also called “adjustable rate mortgages”. It is an interest rate that tends to fluctuate with changing market conditions due to economic fluctuations and is the opposite of the fixed interest rate where the rate stays the same throughout. throughout the term.
Variable interest rates are adjusted periodically, depending on the terms of your loan. It can be quarterly, half-yearly or annually.
- Is linked to the repo rate
These interest rates are directly linked to the repo rate, which is the rate at which banks borrow from the Reserve Bank of India (RBI). Compared to a fixed interest rate, variable rate mortgages are relatively profitable in the long term.
- Applies base interest
If you choose floating interest rates for your home loan, you must pay base interest as an additional element to your loan. This base salary is simply the minimum interest salary set by the lender. Thus, when the base rate is changed, the variable rate is also influenced. This is determined by the RBI based on various economic factors.
- Can fluctuate but is cheaper
The strong dependence of floating interest rates on market trends leads them to fluctuate in the short term. However, it is relatively cheaper than the fixed interest rate.
Although there is no maximum limit on the rate increase allowed, the borrower ends up saving more even when the interest rate increases by 1-2% or more when a variable interest plan is selected because as interest rates rise, the variable interest rate is usually adjusted so that instead of increasing the monthly payment, the term of the loan is extended.
When market rates fluctuate down, floating rates are adjusted again to reduce the term of the loan instead of impacting the monthly payment.
- Does not impose any prepayment penalty
Floating interest rates offer no prepayment penalty. The RBI has banned any type of prepayment charge imposed on any switch to lower interest rate, in case of floating interest rate. However, this advantage does not exist in fixed interest rates because the prepayment penalty condition remains if you close the loan before the scheduled repayment period.
Lately, floating interest rates are gaining popularity among home loan borrowers, with a number of public and private banks offering floating interest rates as low as 6.7%.
The nature of floating interest rates is very unpredictable, making it difficult for borrowers to plan their budget. Therefore, this option might not be suitable for someone who wants certainty and stability in their EMIs, as the interest rate changes often.
There are occasions when the interest rate would increase to such an extent that it would become slightly inconvenient for borrowers to pay their EMIs. This is because they are highly dependent on market conditions, which can be unpredictable.
- May attract higher premiums
When the market is unfavorable, financial institutions may charge higher premiums than the benchmark rate affecting the pockets of borrowers.
- Makes financial planning difficult
Every time a loan rate changes, EMIs can potentially change. This can add a level of uncertainty to your experience and to your monthly financial planning. Furthermore, you can only save if the variable interest rate does not stay above 11% to 11.5% for long.
How to choose between fixed or variable interest rates
Since the interest rate is one of the main deciding factors to qualify for a home loan, the choice between these two options is always tricky. Fixed and floating interest rates have their pros and cons. Your selection should be based on the option that gives you the financial convenience you expect from your loan.
In arriving at this decision, it is ideal to choose the type of loan that best suits your income and other needs, because although the variable rate may be cheaper than the fixed interest rate, it may be difficult to plan your budget. At the same time, if a fixed interest rate offers flexibility, chances are you’ll end up paying a high price.
Depending on your age bracket, the fixed rate might be an ideal choice for borrowers who are in their 40s, as they will feel safe paying equal EMIs without any surprises. Borrowers in their twenties are more risk averse and have plenty of time to repay the loan. Therefore, it will make sense for them to opt for a variable interest rate.
Here’s how much you pay
One option may be suitable for someone and the other for another, so choosing fixed or floating will depend on your needs and financial profile. Your choice will have a big impact on the IMEs you pay, so do your due diligence and make an informed decision that’s right for your financial situation.
For example, suppose you take a home loan of INR 1 cr for 20 years where the fixed interest rate offered to you is 8.5% and the floating interest rate offered is 6% at the start, 7 % after 36 months and 8% after 72 months.
Now, if you choose a fixed rate, your EMI will be INR 86,782 and the total amount payable will be INR 2.8 cr.
If you choose a variable interest rate (the interest rate increases), your EMIs will be:
- Start (6%) – INR 71,643
- From 36th month to 72nd month (7%) – INR 76,818
- After 72 months (8%) – INR 81,410
- And the total amount to be paid is INR 1.9 cr
If chosen at a floating rate (the interest rate is decreasing) then your EMI will be:
- Start (8%) – INR 83,644
- From 36th month to 72nd month (7%) – INR 78,188
- After 72 months (6%) – INR 82,059
- And the total amount to be paid is INR 1.58 cr
The difference of 5,000 to 6,000 INR may seem small, but can make a big difference in the total amount when calculated for a total term of 20 years. Since floating rates are unpredictable and can decrease or increase over time.
In Scenario 1, when the interest rate ranged from 6 to 8%, the total amount payable was INR 1.9 cr and in the case of the fixed interest rate, the total amount payable was 2. 8 cr INR. The total amount saved is almost INR 90 lakh which is a huge amount and even if the market fluctuates and the interest increases, you will still save money.
Some popular banks and non-bank financial companies offering these two interest rates include:
- Axis Bank
- YES Bank
- ICICI Bank
- HDFC Ltd
- Hero Housing Finance
- Tata Capital housing finance
- Capital India Home Loans
- IIFL (India Infoline) Home Finance
Still can’t decide? Maybe consider alternative options
Split the loan
If you still can’t decide between a variable rate or a fixed rate, there is also an option to split the loan between the two rate types. It’s also beneficial when people don’t want to be charged during loan prepayment. This means allocating half of the portion to the fixed home loan and the other half to the floating home loans or you can choose to keep it at a ratio of 60:40 or another ratio depending on your financial needs.
Switch from a fixed interest rate to a variable rate and vice versa
It makes sense to lock in to a fixed rate when there is a clear indication that the interest rate might go up. But as a borrower, it is also justified to be confused about the interest rate you have chosen and you may want to switch from floating to fixed or vice versa in the future. Thus, you can consider switching from one type of rate to another.
Conversion fees will be between 1.75% and 2% depending on the amount of the loan and the bank you choose. The answer is to do the math and be clear about how much interest you save and how much fine you will pay.