Way back in 2010, when I bought a residential property, I took a home loan to fund my purchase.
Now, the way most people would approach loans is to see how much EMI they can afford to pay. The property size (2BHK or 3BHK), location (town or suburbs), loan amount and the tenure are decided according to that number.
But there is one more aspect which should not be ignored at all and which will ultimately play a major role in determining your EMI. That is the interest rate option.
While finalising the loan agreement, one of the questions that I had to answer was what type of interest rate option I would like to go for?
A fixed interest rate OR a floating interest rate?
I believe every home buyer has to make this choice. But how?
Let’s do the basics first.
What does a floating and a fixed rate mean?
A fixed interest rate means that your interest rate will be decided at the time of finalising the loan agreement and it would remain constant for the term of the loan.
For example, if you take a Rs. 20 lacs loan for 20 years at a fixed interest rate of 11%, then your interest would be constant at 11% for the entire 20 years. It does not change.
The advantage of a fixed interest rate option is that you will be locked into one rate. No changes and you know exactly what you are paying.
In case of a floating interest rate, the interest rate is based on a reference rate. Typically, the reference is the Basic Prime Lending Rate or BPLR of the bank. BPLR is the rate, which the bank offers to its best customers, when they borrow money.
So, in case of a floating rate loan, the bank would charge you the BPLR + an additional markup which is decided by the bank. Hence, if the markup is 2% then whatever the BPLR, the interest rate applicable to you would be 2% over the BPLR.
For example, if the BPLR is 8%, then you would pay an interest at 8% + 2% = 10%. If the BPLR changes to 11%, then you pay 13% (11% + 2%). Simple.
The advantage of a floating rate option is that if the BPLR of the bank falls, then your interest rate also comes down and you pay less. This happens typically when the RBI reduces interest rates and which, sometimes, result in banks also lowering their borrowing interest rates.
But the basic rate can also go up which means the payment tenure of your home loan will also increase (assuming the EMI remains the same).
Some important points to consider with your home loan
- The fixed rate loans do not really have ‘fixed rates’ for the entire tenure. I have come across practices where the bank or housing finance company reserves the right to change rates after every 5 years or so.
- In case of floating rate interest loans, you have to keep an eye on the interest rate you are paying and whether it is adjusted to the change in the BPLR.
- If you feel that the option you chose earlier is leading to more interest payment, you can convert your loan from a fixed rate to a floating one and vice versa, by paying a conversion fee.
- Switching costs are zero these days. If you get a good interest rate offer from another bank, consider switching your loan. But make sure that you understand the terms well.
- You should negotiate hard, right in the beginning, on your interest rate, specially if you have a good credit score.
- Finally, don’t sign on the dotted line until you understand the whole working of the loan and interest over its tenure.
Several times, the banks give loans at lower rates of interest to new borrowers but do not pass on the benefit to the existing borrowers who opted for the floating rate home loans. I consider this a malpractice.
What should you choose – fixed or floating rate?
There are no true blue fixed interest rate loans that exist today. However, if you want to have the certainty of the fixed rate option, to whatever extent it is available, then choose the fixed interest rate option.
However, if you understand how interest rates work or you can take good advice that the interest rates are headed downwards, then a floating rate home loan would make greater sense.
My own experience with a home loan
5 years ago, when I opted for a floating interest rate, I made myself believe that interest rates were to go down from that point. I also got this special offer where I would pay 8% for the first year and then 9% for the next 2 years followed by a floating rate pegged to the bank’s internal benchmark rate.
I recently checked and the interest rate is 11.95%. When I said it is too high, the bank made me an offer to reduce the rate to the ‘current rate’ of 9.75% by paying a nominal fee of 0.57% of the principal outstanding.
I know why they are doing so. It is easy and free to switch loans. So all banks are trying to lure each others’ customers to transfer their loans. My bank too, which happens to be the largest player in the space, has floated this scheme to retain its customers.
I find it ridiculous. If they are calling 9.75% the current rate, why would they not just give it to me?
I believe most people would still opt for this scheme than go through the hassle of all the paperwork related to the transfer or switch to another bank.
Interesting read: Monica Halan, Livemint on Home Loans that defy gravity
Between you and me: So, dear reader, will you be able to make a choice between floating and fixed? Isn’t that some philosophy here? 🙂
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