Difference between fixed and floating interest rates

With interest rates on home loans on the rise, read on to find out how this rise will impact your home loan.

The home loan industry is booming. Every young aspirant's dream of buying a home is a reality waiting to happen as banks and housing finance companies have been successfully meeting people's demand at some of the lowest interest rates in the history of housing loans. However, last week, RBI announced a hike of 50 basis points (0.50 per cent) in interest rates for home loans. How will this development affect the home loan taken by you?

Impact on floating interest rate home loans

Any change in interest rates on home loans will instantly impact those who have opted for a floating interest rate home loan. For instance, assume you have taken an Rs 10 lakh floating rate home loan at 7.5 per cent per annum for a 20-year term. Based on this, you would have to pay an EMI of approximately Rs 8,060. However, suppose a few months into the home loan, the interest rate for home loans increases by 0.50 per cent. Your lender will now increase your loan tenure to accommodate the rate hike instead of increasing your EMI so as not to upset your income net of EMI. Instead of paying EMIs for 20 years, you will now have to pay the same EMIs for approximately 22 years. Harsh Roongta, CEO of Apnaloan.com says, "Depending on the fluctuation in the rate of interest, the lender will keep your EMI constant and either increase or decrease the term of the loan."

Impact on fixed interest rate home loans

A fixed interest rate home loan will not be affected when banks and housing finance companies revise interest rates on home loans.

Shifting from a floating to fixed interest rate and vice versa

Today, you have the option to shift from a floating to a fixed interest rate home loan or vice versa. However, keep in mind that shifting from a floating interest rate to a fixed interest rate home loan is expensive and the cost of conversion is high. For instance, HDFC charges 1.5 per cent of the loan amount converted, to facilitate the conversion in the interest rates. Other lenders charge as high as even 2.5 per cent of the amount to be converted. This holds true even when you wish to shift from a fixed interest rate home loan to a floating interest rate home loan.

Further, it is important to consider the stage that your loan is at, when a revision in the interest rates has taken place. If you have already completed more than threefourth of the loan tenure then it does not make much sense for you to shift from the floating to the fixed interest rate option or vice versa. This is because the benefit of a shift for a short duration will be marginal and may be neutralized by the cost of the conversion.

Fresh home loans

All fresh home loans (either fixed or floating) will be calculated at the revised rate of interest.

Which is the best option? Fixed or Floating?

Whether you should opt for a fixed or floating interest rate option depends entirely on you. If you believe that interest rates will continue spiraling, you can insulate yourself by taking a pure fixed rate loan. Although this will keep you safe from further interest rate hikes, you will not benefit from any fall that may take place in the interest rates in the future.

If you do not have a clear view on long-term interest rates, take a loan, which is partly based on a fixed interest rate and partly on a floating rate. If you feel that in the short-term interest rates will rise, then you can opt for a floating interest rate home loan and then shift later on to a fixed interest rate home loan.

However, if you feel that interest rates are likely to follow a downward trend in the future, then opt for the floating rate option. Here you would be able to enjoy the benefits of a fall in interest rates.