Shilpa
Sharma, 44, is a mother of two and works with an IT firm. She earns a modest
income and has been living with her parents since her husband died three years
ago. Sharma feels it is time she bought her own house. She has approached
lenders to inquire about home loans and is caught between choosing a fixed rate
and a floating rate loan. Which one should she opt for?
It is
important for Sharma to bear in mind that predicting the future interest rate
is tougher than deciding the EMI she can pay. A fixed rate home loan, in which
the interest rate is pre-fixed for the tenure of the loan, provides a known
cash outflow for a known period. The risk for Sharma is that she might lock in
at a high rate for a long period in the future.
In a
floating rate home loan, the interest rate changes as per the market rates over
the tenure of the loan. Sharma will be affected by the change in the reference
rate of interest indicated by the bank, which, in turn, is linked to market
rates of interest. Lenders typically adjust the tenure of the loan and keep the
EMI constant in floating rate loans.
If interest
rates were to fall in the future, Sharma will benefit from a reduction in her
repayment tenure. If the rates move up instead, her repayment tenure can
increase. In both the cases, Sharma should focus on the monthly installment and
make sure that she is able to pay the EMI comfortably and is left with enough
money to meet her other needs.
Which
home loan is best fixed or floating, the bank bears the risk of the rates going up in the
future, while in a floating rate loan, Sharma bears this risk. Except in a
fortunate situation, where Sharma is able to lock in at a very low fixed rate,
a floating rate loan is a better option as it does not try to guess the future
rates.
Sharma
should understand that her bank may have a better view of interest rates than
her. A good clue may lie in the pricing. Fixed rate loans may be priced higher
than floating rate loans if the bank believes that the rates will rise. It
helps the banks to earn more as rates increase through the floating rate
option.
If the fixed
rate is priced lower than the floating rate, the bank is anticipating a fall in
interest rates. It helps the bank to lock in at a higher fixed rate. It is also
important to find out whether the fixed rate home loan is for the entire tenure
or partial term of the loan since most lenders offer a loan that is fixed for
the initial two to five years, after which it is converted into a floating one.
