Fixed vs Floating Home Loan Interest Rate Explained
October 07, 2024
When applying for a Home Loan, you have the option to choose between fixed and floating interest rate. Choosing any of the two can have a significant impact on your EMI (Equated Monthly Instalments). So, before you apply for a home loan, it is important to understand the difference between fixed and floating home loan interest rates and how they can influence your EMIs.
What is Floating Interest Rate Home Loan?
Floating interest rates are influenced by market fluctuations, meaning the interest rates may change (higher or lower) during the tenure based on the bank’s benchmark rate. Benchmark rates depend on MCLR (Marginal Cost of Funds-based Lending Rate) or Repo rate. Banks are not allowed to offer interest rates below the benchmark rate.
Generally, banks use MCLR or repo rate (depending on the linked benchmark) to determine interest rates. The home loan interest rate comprises MCLR + spread/margin or Repo rate + spread/margin. For example, if the MCLR is 5% and the spread is 3% the applicable interest rate would be 8% p.a. Same for repo-rate linked home loans. Now, this additional interest rate levied above the benchmark rate, commonly known as ‘spread’ depends on multiple factors including your home loan eligibility.
Now you may ask what’s the difference between MCLR and repo rate? To put it simple words, the Repo rate is decided by the RBI (Reserve Bank of India) while the MCLR is set internally by banks and includes (Weighted Average Cost of Current and Savings Account Deposits + Borrowings + Term Deposits) + Operation Costs + Tenor Premium.
Okay, let’s get back to the point. For floating interest rates, the interest rate may change based on any changes in the benchmark rates. If the benchmark rate increases, the interest rate will also increase, impacting your EMI or loan tenure. Similarly, if the benchmark rate decreases, the interest rate will also come down, resulting in lower monthly EMIs or tenure.
Generally, banks adjust home loan rate changes against the tenure.
Disadvantages of Floating Interest Rate Home Loan
If the bank increases MCLR or the RBI hikes repo rate, the interest would also go up, directly affecting your home loan tenure or EMI. This may derail your financial planning and might put a strain on your financial life.
What is Fixed Interest Rate Home Loan?
Fairly simple to understand, fixed interest rates remain unchanged throughout the home loan tenure, regardless of any fluctuations in benchmark rates. This means that your EMIs will remain constant over the entire repayment period, offering stability and predictability in your monthly budgeting.
Disadvantages of Fixed Interest Rate Home Loan
Fixed interest rates are typically 1.5% to 2% higher than floating rates, leading to higher initial monthly payments. Additionally, if benchmark rate decreases, you won’t be able to capitalise on the lower rates and will continue paying the same amount. This lack of flexibility can hinder potential savings and limit your options if your financial situation changes.
Comparing Fixed vs Floating Interest Rates
To help you make an informed decision, let's compare both the types of interest rates:
| Parameter | Fixed Interest Rate Loan | Fixed Interest Rate Loan |
| Interest Rate Stability | Remains fixed throughout the loan tenure | Can change based on market and benchmark rate |
Market Dependency | Not affected by market fluctuations | Interest rate may change based on market fluctuations |
| EMI Predictability | Predictable because the interest rate remains constant | EMIs may change throughout the tenure |
| Interest Rate Charged | Higher compared to floating rates | Lower compared to fixed rates but may increase if the benchmark rate increases |
| Prepayment Penalties | Higher compared to floating rates | No prepayment penalty fee |
| Long-term Cost | Overall loan cost could be higher if the benchmark/market rates decrease | Overall loan cost could be higher if the benchmark/market rates decrease |
| Budget Planning | You can plan your finances easily since the EMI is fixed | Difficult to predict as rates may change resulting in higher or lower EMIs |
Can I Switch Fixed Rate Home Loan to Floating Rate?
Yes, you can change your fixed interest home loan to floating interest rate home loan and vice versa subject to terms and conditions. You may have to pay a certain fee for the switch. Please check with your bank to understand other terms and conditions.
Which Interest Rate is Better for You?
Both fixed and floating rate home loans have their share of pros and cons. For instance, EMIs are constant for fixed rate loans, allowing you to plan better. But fixed rate home loans come with prepayment penalties. Additionally, you won’t be able to capitalise if there’s a drop in interest rates.
For floating rate loans, you may benefit from lower rates, especially if benchmark rate decreases. Also, you can foreclose your loan without any penalty charges. But what happens if the market rate increases? Are you prepared to take the burden of increased EMIs or extended tenure?
Consider these factors before selecting fixed or floating rate for your home loan.
Final Thoughts
Choosing between fixed vs floating interest rates for your home loan is a crucial decision that can impact your financial well-being in the long run. While fixed rates offer stability and predictability, floating rates provide flexibility and potential cost savings. It's important to consider factors such as your loan tenure, risk tolerance, and market conditions before making a decision.
Ujjivan SFB offers affordable home loans customised to your needs. Whether you want a loan for plot purchase or to renovate your house, we have them all!
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