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Home buyers all over the world often deal with a common dilemma – whether to opt for a floating or a fixed interest rate when availing of a home loan. While there are enough and more arguments to support either of these options, the answer to this question is indeed very subjective. In reality, fixed and floating rates of interest suit different borrowers.
A fixed interest rate simply implies that the interest rate remains static for the tenure of the loan. Hence, in this case, the repayment of the home loan takes place via fixed equated monthly installments (EMI) over the entire period of the loan. In the early years, the majority of monthly payments are used to service the interest component while the principal component is served in the later years.
Since the interest rate remains fixed irrespective of market conditions, this option allows easy budgeting via a fixed payment fee and schedule. Also, it is particularly beneficial to the borrowers if the market interest rates are threatening to rise. However, the downside is that, if for any reason the interest rate decreases, the fixed rate home loan does not get the benefit of reduced rates. Also, fixed interest rates are generally higher than floating rate home loans and are, thus, preferred by borrowers who need stability and are willing to pay a premium for it.
Floating interest rates change as per the market rates over the tenure of the loan, and this can be revised by the bank any time. Home loans based on floating interest rates are tied to a base rate plus a margin. Since the base rate is linked to the market rate of interest, any variation in the base rate will cause the floating interest rate to vary as well.
As mentioned above, a floating rate home loan is cheaper than a fixed rate one and leads to considerable savings in the long term. More importantly, even if the floating rate goes over the fixed rate, it will be for some period of the loan and not the entire tenure. And in a scenario where interest rates are poised to fall, it becomes all the more favorable. However, due to its element of uncertainty, floating rates are preferred by borrowers who are certain they can weather market volatility.
In the end, it is up to the individual borrower to decide what type of home loan suits him best.
• There is no perfect choice between a fixed and a floating rate of interest
• Fixed interest rates guarantee borrowers peace of mind but at a higher cost
• Floating rates are cheaper but recommended for financially secure borrowers
Source: Priyanka Wade, Special to Properties
The writer is a freelancer