A home loan is probably going to be the biggest and longest liability you will ever take on. One of the most important factors in taking a home loan is the interest rate. This is what will determine your cash outflow every month, for a number of years.
Wondering whether you should opt for a fixed rate or a floating rate or take a hybrid loan?
Let us help.
There are 3 types of home loans available: fixed, floating and hybrid (also known as dual rate home loans).
A Fixed rate home loan is one where the interest rate charged is supposed to be constant over the loan tenure.
A Floating rate home loan is one where the interest rate changes based on a specific benchmark rate (the base rate), over the tenure of the loan.
A hybrid / dual rate home loan is a combination of fixed and floating rates loans where some proportion of your loan is fixed and the rest is floating. The recently introduced teaser rate home loans are a type of hybrid loan – where they offer you a fixed rate for the first few years ( 1 to 5 years) and afterwards the rate reverts to the standard floating rate. These are called teaser loans because the rate for the first few years is low (currently between 8 and 9.50%) and thereafter it becomes floating i.e. around 12% or more.
Now for some nitty gritties:
Is a fixed rate home loan really fixed?
No. The rate isn’t really constant for the whole duration of your loan.
The rate is ‘fixed’ for a period of time – say 3 years or 5 years, and the lender can then change the rate, to keep it ‘fixed’ again, for the same period of time. So, in case interest rates have risen significantly, your lender can revise your rate upwards too.
When is a fixed rate loan better?
A fixed rate loan works well when the fixed rate is low i.e. when the economy is at the bottom or close to the bottom of an interest rate cycle. That’s when you can lock in a low fixed interest rate and benefit from it, atleast for 3 to 5 years when the rates can be revised by your lender.
The time you should not opt for a fixed rate loan, is at the top or close to the top of an interest rate cycle, when interest rates are high. And remember, the rates can change in a few years anyway, so actually, there is no fixed rate.
When is a floating rate better?
A floating rate home loan is the more popular option because when market rates go down, floating rate owners get the benefit of the fall in interest rates. This is one of the reasons the majority of people taking a home loan go for floating rather than fixed rate loans. Another big factor in favour of floating rate loans is that they are usually available for about 1% to 2% lower than fixed rate loans.
What happens to a floating rate loan when interest rates change?
If you have a floating rate home loan, and interest rates go up, then either your EMI will increase, or your loan tenure will increase and your EMIs remain constant.
Similarly, if interet rates go down, then either your EMI will decrease, or your loan tenure will.
I have already taken a fixed rate home loan, can I convert it to a floating rate home loan?
Yes – the bank will charge you a nominal fee but you can certainly convert from floating to fixed, and also vice versa.
What should I choose today - a fixed rate, floating rate or hybrid?
In today’s scenario, interest rates are close to a peak so both a hybrid and a floating rate home loan would benefit you when interest rates fall. But specifically, a hybrid rate home loan would be more beneficial because you can take advantage of low rates for the first couple of years, and then let your rates float. Please note, you should look into the details of your specific loan very carefully before opting for it.
Also, you should be sure that when the low interest rate period is over and you move to a high interest rate, your cash flows can sustain the increased outgo on EMIs.
Given here is a table which will show the EMI for a home loan of 15 year tenure, of different amounts (Rs. 20 lakhs, Rs. 30 lakhs and Rs. 50 lakhs), at two different rates of interest - 8.50% and 12.50%. This will help to see how EMIs will increase once the teaser rate period of the hybrid rate home loan ends and the regular floating rate period begins.
Loan Amount (Rs) Interest Rate 20L 30L 50L 8.50% 19,695 29,542 49,237 12.50% 24,650 36,976 61,626
On a Rs. 30 lakh loan taken for a 15 year tenure, at 8.50% interest, EMIs for the period where interest rate is 8.50% comes to Rs. 29,542 per month. When interest rates increase to 12.50% (for example), EMIs increase to Rs. 36,976.
The RBI has recently hiked rates, how will my home loan be affected?
When the RBI hikes its rates, the rate hike is over a short period of time passed down to the end consumer. It can be expected that interest rates on not only home loans but car loans, personal loans and all other loans will move upwards as well.
Remember, whatever you choose – be sure you can service the loan based on your cash flows, and also remember to insure your loved ones from the liability by taking the requisite term plan cover for the loan amount.
And lastly, do consult your financial planner to help you plan for your home loan to buy that dream house!
Fiancial Planning Article
Disclosure: Short YHOO