In the current scenario of falling interest rates, one finds it difficult to take a decision of buying an asset via finance. The decision becomes even more difficult if it pertains to buying a property. This is primarily because housing loans are long term in nature with the term extending up to 30 years (ICICI Home Loan). So if you take a loan to buy a property and if the interest rate drops, as has been the case for the last couple of years, you stand to lose significantly.
It is very difficult to predict interest rate movement and so it becomes even more difficult for loan seekers to decide whether to wait for the drop in interest rate or buy outright. The problem is if you have identified a property and waiting for interest rate to drop before you buy it via finance, the property may have been sold to another buyer.
To address this problem of loan seekers, housing finance companies (HFCs) have come out with floating interest rate home loan scheme in addition to the already existing fixed Interest rate scheme.
Fundamentals of fixed and floating interest rates:
Floating interest:
Under this scheme the rate charged varies with a benchmark, which is the generally prime lending- rate (PLR). Most of the nationalised banks and foreign banks offer floating rate linked to their PLR on the other hand most of the HFCs offer fixed rate loan, with an exception of HDFC which has Adjustable Prime Lending Rate (APLR) or in simple words floating rate home loan scheme.
The basic problem with the floating rate scheme is, your liability per month (EMI) or the term of the loan keep on changing as the interest rate move up or down. Whenever the interest rate changes (assume that it comes down) the HFCs either decrease the amount payable per month (EMI) or let EMI remain same and decrease the term of the loan. Of course, the choice is with the consumer to either opt for reduced EMI number (reduced term) or reduced value of EMI (pay less per month).
Floating interest rate scheme basically means that a consumer is exposed to market risk/condition and his gain/loss is totally dependent on the interest rate condition prevailing in the market. As a thumb rule, floating rate is beneficial in a falling rate scenario and becomes costly as the rates moves up.
Fixed Interest:
Under this home loan scheme the interest rate charged by HFCs remains fixed or same through out the term of the loan. This means that the consumer is immune to market risk/condition and the fluctuation in the interest rates.
This scheme enables the consumer to know his liability per month in advance (EMI), which will remain fixed throughout the term of the loan. This helps in better financial planning for cash inflows and out flows of consumers, as he is aware of his liability per month (EMI) over the term of the loan. But the consumer may not have the opportunity to gain from current falling interest rate scenario.
Lets take an example to understand it more clearly:
HDFC Home Loan ‘Fixed and Floating’ rate scheme:
| Schemes |
Loan
(Rs) |
Interest
(%) |
Year |
EMI
(Rs) |
Total
Payment (Rs) |
| Fixed |
1,000,000 |
12.25 |
15 |
12,400 |
2,232,000 |
| Floating |
1,000,000 |
12 |
15 |
12,236 |
2,202,480 |
Lets assumes two scenario at the end of 5 years:
1) Interest rate drops by 1%
2) Interest rate move up by 1%
Scenario 1: Interest rate drops by 1%
| Scheme |
Fixed |
Floating |
Difference |
| Loan Outstanding (Rs) |
839,667 |
829,590 |
10,077 |
| Interest (%) |
12.25 |
11 |
1.25 |
| Year |
10 |
10 |
- |
| EMI (Rs) |
12,400 |
11,739 |
661 |
| Total Payment (Rs) |
2,232,000 |
2,142,840 |
89,160 |
Scenario 2: Interest rate moves up by 1%
| Scheme |
Fixed |
Floating |
Difference |
| Loan Outstanding (Rs) |
839,667 |
829,590 |
10,077 |
| Interest (%) |
12.25 |
13 |
-1 |
| Year |
10 |
10 |
0 |
| EMI (Rs) |
12,400 |
12,741 |
-341 |
| Total Payment (Rs) |
2,232,000 |
2,263,080 |
-31,080 |
The table above clearly indicates that if interest rate drops by 1% and remains at that level for rest of the term of the loan (10 yrs, assumption) you stand to gain up to Rs 89,160 over the term of the loan but if interest rate move up by 1 % and remain at level for rest of the term of the loan you end up losing Rs 31,080. The potential gain is much higher than the potential loss, worth taking the risk.
So, we see both these home loan schemes, ‘Fixed and Floating interest’ has its own pros and con’s. It all depends upon individual’s perceptions towards interest rates and market conditions. But one thing is for sure if the Government’s indication of bringing down the interest rate over the long term is to be taken seriously then there is every chance that you as a loan seeker are going to be better off opting for floating rate scheme as it will result in substantial saving over the term of the loan (if interest rate drop further). However, you stand to lose if by any chance the interest rates move up. This is because all housing loan are long term in nature, some time even 30 years and it is almost next to impossible to predict interest rate trend for such a long term with reasonable accuracy.
If you have appetite for risk and want to save money over the term of the loan, opt for floating rate scheme. But if you want peace of mind even if it comes at a price, fixed rate would be the better option: Choice is yours!
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