Shikha should know that predicting future interest rates is more difficult than deciding how many EMI she can comfortably pay. A fixed rate home loan in which the interest rate is prefixed for the term of the loan provides a known cash outflow for a known period. The risk for Shikha is that this may turn out to be a high rate that she locks into for a long time in the future.
In a variable rate home loan, the interest rate changes on a quarterly basis based on market interest rates during the term of the loan. It will be affected by the change in the base interest rate indicated by the bank, which in turn is linked to market interest rates and economic factors. Lenders usually adjust the term of the loan and keep the EMI constant in variable rate loans. Should interest rates fall in the future, Shikha will benefit from a reduction in its repayment term. If the rates increase instead, its repayment term may increase.
Bonanza for borrowers: low interest rates on home loans and other holiday deals
Festive cheer on home loans
The holiday season has started and banks as well as non-bank financial institutions have already rolled out a plethora of festival offers such as lower interest rates on loans and waivers of processing fees. Indian banks are aggressively pushing loans for purchases of homes and gadgets at record interest rates, capitalizing on holiday optimism.
Last month, Finance Minister Nirmala Sitharaman called on state banks to step up lending and set up credit programs across India from October to bolster various stimulus packages. With the return of the awareness programs thus planned, the flow of credit to the productive sectors of the consumer economy is expected to increase further. Here’s the joy some major lenders bring you this holiday season.
In either case, it is on the EMI that Shikha should first focus on and ensure that she is able to afford it comfortably and that she has enough surplus for other needs. The main difference is that in a fixed rate loan, the bank bears the risk of rising future rates, while in a variable rate loan, Shikha bears the risk that future rates rise. With the exception of a lucky situation where Shikha is able to lock in to a very low fixed rate, an adjustable rate loan is a better option as he does not try to guess at future rates.
Shikha needs to know that her bank may have a better view of interest rates than she does. A good clue may lie in the price. Fixed rate loans can be more expensive than adjustable rate loans if the bank thinks the rates will go up. It helps banks earn more as rates go up with the variable rate option. If the fixed rate is lower than the variable rate, the bank anticipates a drop in interest rates. It helps the bank to lock in to a higher fixed rate. It is important to know whether the fixed rate home loan is fixed for the entire term of the loan or not, as most lenders offer a loan that is fixed for an initial term of 2 to 5 years and then it becomes floating.
(The content on this page is courtesy of the Center for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava, and Labdhi Mehta.)