Floating rate or fixed rate?

The rate of interest on home loans comes with two options: floating rate or fixed rate. Home loan borrowers are at a loss when it comes to deciding which one to choose between the two. When they look closely at the two options, they find that the fixed rate home loans come at interest rates that are usually higher than floating rate home loans, so they might be instinctively tempted to go for home loans with floating rate of interest. But is it the right approach to borrowing home loans that are long-term and big-ticket loans? Let’s find out.

A floating rate home loan means that the rate of interest on the home loan would move in tandem with the movement of interest rates in the market, so if the market rates go up, the home loan rate too goes up, and when the rates go down, the home loan rate too goes down. Therefore, the interest rate risk is higher in the case of floating rate home loan. However, when the interest rate cycle is at the higher end of the curve and the rates are expected to decline substantially in future, it makes sense to go for floating rate home loans. Conversely, if the rates are expected to go up, it would be unwise to choose the floating rate option and this will result in increased interest outgo in future.

On the other hand, if the interest rate cycle is at the lower end of the curve and the rates are expected to rise in future, it makes sense to opt for fixed rate home loans and freeze the rate at the lower level. Also, if the interest rate cycle is at the higher end of the curve, it would be imprudent to go for fixed rate of interest and thereby deprive oneself of lower rate of interest in future. However, it must be noted that the lender reserves the right to revise the interest rate if the difference between the fixed rate and market rate crosses a certain pre-determined limit.

So, depending on the prevailing interest rate scenario, one must choose between the fixed rate and floating rate options.