Did you know? There are 3 types of rates of interest

The interest rate plays a crucial role in determining the final debt figure for any loan, and the same applies to home loans. Therefore, considering the home loan interest rate is crucial when deciding on the financial institutions to go with.

But there is a caveat; there are 3 types of interest rates applicable on a housing loan, fixed, floating and semi-fixed. So, which one is ideal for you, and gives you the best possible deal, well, that’s something you need to decide after checking each of them carefully.

So, let’s get going.

3 interest rate options for you to choose from

So, here are the three interest rate options available on a home loan for you. Here you will get the advantages and disadvantages of each type for you to make a decision.

Fixed interest rate method 

As the term ‘fixed’ suggests, the interest rate, in this case, will remain the same throughout the loan tenure. It means, for instance, if you have borrowed funds at a 7% interest rate to purchase a property, then it will remain that 7% irrespective of the tenure you opt for. Therefore, even if the market rate increases or decreases, it will not change.

Benefits of opting for a fixed interest rate method

Here are the advantages of choosing the fixed interest method –

No effect of market fluctuations: One of the biggest advantages of opting for this facility is that there will be no fluctuations. So, even if the Reserve Bank of India (RBI) adjusts the repo rate and the home loan interest rate goes up, you will still be paying the rate you agreed to.

Helps in budgeting: Since the interest rate is fixed, and you already know the EMIs, you can adjust your budget accordingly. You will plan your finances and ensure you are not struggling to meet the repayment.

Better financial security: With this loan interest option, you are secured financially. You don’t need to worry about future fluctuations; just focus on managing the repayments.

Drawbacks of opting for the fixed interest rate method

Here is the drawback of this interest rate method –

No benefit in case the market falls: So, in case the RBI adjusts the repo rate and the home loan interest goes below what you have agreed on the loan, then you will not receive that benefit. As a result, over the tenure, this interest rate will prove expensive, as you will pay more.

Charges on prepayment: When you decide to pre-pay or foreclose your home loan at the fixed interest rate, you need to pay the penalty. The amount will be specific to the financier you are dealing with, but you will need to bear this additional charge.

Floating interest rate method

As the term suggests, a floating interest rate is diametrically opposite of the fixed interest method. Here the interest rate is directly related to the market movement and changes accordingly. It can go up or down as per RBI’s policies.

A floating interest rate method has two portions, benchmark rate and index. The benchmark rate is the interest rate on a home loan set per the RBI’s policy, and the index or spread is what the financial institutions add as profit.

Now, this spread part of the home loan interest changes as per the lender selection, and it remains constant. The benchmark, however, changes as per the market movement.

Advantages of opting for a floating interest rate method

Here is how you can benefit from a floating interest rate method –

Cost-effective: A floating interest rate proves to be cost-effective. With a longer tenure of a housing loan, there is a chance that the interest rate will go down. Moreover, a small change of as low as 0.25% can make a substantial difference.

No prepayment charges: As per the apex bank of India, any home loan serviced at a floating interest rate is not subjected to an additional prepayment charge. Thus, you get a chance to save significantly while foreclosing the loan or making prepayments.

Disadvantages of opting for a floating interest rate method

Here is how this interest rate method can be a hindrance –

It is unpredictable: The nature of this interest rate method is its most significant disadvantage. Since you do not know how the market will behave in the coming years, it isn’t easy to adjust your finances accordingly. If the rates are low, it’s excellent; you will pay less and complete the repayment early. But, if the rate goes up and does not come down, you will be in trouble as your EMIs will go up.

Semi-fixed interest rate method

The semi-fixed interest rate method on home loans combines fixed and floating interest rates. Here the housing loan interest rate remains fixed for a specific period and then switches to the floating rate.

Pros of opting for the semi-fixed interest rate method

Here is how opting for this interest rate method can help your finances –

Get the best of both worlds: With the semi-fixed interest rate method, you get to enjoy the stability of a fixed interest rate and the flexibility of a floating interest rate. So, you get to experience both the systems and their benefits.

Can be financially viable: Opting for this method can also be financially viable in a scenario where the market volatility is high and your loan switches to a floating rate; you can reap the benefits of that situation and save substantially on the repayment.

Cons of the semi-fixed interest rate method

Here is why this is not a feasible option for you –

Can be difficult to adjust: The switch from fixed to floating can be challenging, especially if the EMIs are rising.

Parting thoughts

So, these are your three interest rate options for your home loan. Since all of them have benefits and drawbacks, you need to make an informed decision based on your current and future financial conditions.