Floating vs Fixed Interest Rate: Which is better for Loan Against Property?

How does a fixed interest rate on a loan against property work?

 
A fixed interest rate is ideal for those who strictly adhere to their monthly budget and are uncomfortable dealing with fluctuating expenses. You can calculate this rate if you are aware of the principal loan amount, repayment period, and interest rate. 
 
Suppose you have applied for a Rs 50,00,000 mortgage loan with a repayment period of 10 years and an interest rate of 8% fixed. If you do not switch to a variable rate, your EMI will be Rs 60,664, and the total interest you will pay at the end of the loan will be Rs 22,79,656.
 

What are the benefits of a fixed interest rate on a mortgage loan?

 
Opting for a fixed-interest loan can help in many ways, such as–
 

1. Prediction

   Since the interest rate remains constant throughout the term, you can easily predict how much EMI you will have to pay next month or after six years. You can also determine the amount of principal debt that is still owed.
    

2. Effective budgeting

   You can easily plan on other monetary aspects if you have to pay a fixed sum monthly towards debt repayment. For example, if you receive an unexpected profit in your business, you can invest the funds in innovative business opportunities.
    

3. Cost calculation

   There are various fees associated with a mortgage loan. For example, if you ever want to pay off your loan in full or in part, you will have to pay a small foreclosure fee. Similarly, if you miss your one- or two-month EMI due to a temporary cash crunch, you will have to pay a penalty for late payment. Calculating these costs is much easier if you have a fixed-interest loan.
    

4. Easy comparison

   Whether you want to compare other lenders based on the interest rate mentioned on the loan approval letter or transfer your outstanding debt to a new lender, comparing fixed-interest loans is much easier. The reason for this is that the lender determines this rate, and external factors have no bearing on it.
    

What are the disadvantages of a fixed interest rate?

 
Fixed interest rates are marginally higher than variable interest rates. Even if the fixed rate is lower at the time of borrowing, because of a sudden change in government policies, the borrowing cost becomes cheaper, and you will end up paying more than those with a floating rate.
 
If you want to switch lenders or ask your current lender to change your mortgage rate, the refinancing cost may be higher, and the process may take longer.
 
Also Read: Key Questions About Loans Against Property Answered
 

What is a floating interest rate on a loan against property?

 
A floating mortgage rate fluctuates throughout the term of the loan. It is influenced by external factors such as inflation, financial market conditions, and the base rate decided by the Reserve Bank of India (RBI). 
 
If the market becomes unfavorable while the rate is raised, your monthly debt obligation will rise. The floating interest rate has two variables: the spread and the index.
 
The spread refers to the portion of the interest rate that the lender decides to charge to reduce credit risk and increase the profit margin on the lending amount. The spread rate varies depending on the lender. On the other hand, the index portion is based on government securities prices and a few other factors. When you choose a floating interest rate, and the rate fluctuates sharply, lenders may make adjustments to the spread portion to keep it within your budget. However, such incidents are extremely rare.
 

How does a floating interest rate on a mortgage work?

 
If your business is doing well and you have enough cash on hand to deal with an increase in interest rates, a floating interest rate is ideal for you.
 
Assume you have applied for a Rs 50,00,000 mortgage loan with a repayment term of 10 years and a floating interest rate. At the time of borrowing, the interest rate applicable to your profile is 7%, and the EMI you must pay is fixed at Rs 58,054. However, after three years of loan repayment, the market becomes unfavourable, and the floating interest rate rises to 9%. In this case, your EMI will also rise. After another five years, the market falls, lowering interest rates to 6%. The EMI will fall this time.
 

What are the benefits of a floating interest rate on a mortgage loan?

 
Choosing a floating rate for your mortgage loan has several advantages. These are as follows:
 

1. Market forecasting

   You can choose this rate if you understand how the market works and have the ability to forecast the market after analysing various economic parameters. It will assist you in better financial planning, and you will be able to easily determine when it is the right time to switch to a fixed rate if interest rates are expected to rise.
    

2. Cost-effective

   Floating interest rates are typically less expensive than fixed interest rates. If you choose this rate for your mortgage loan, there is always the possibility of saving 1-2% on the interest rate.
    

3. No foreclosure charges

   The RBI has mandated all financial institutions not to charge a prepayment penalty if the borrower has opted for a floating rate loan. Hence, if you have any windfall gains and no major liabilities other than a loan, you can choose foreclosure without hesitation.
    

4. Investment opportunity

   As previously stated, a floating interest rate saves you approximately 1-2% on interest payments. As a result, you can invest the money you have saved in a scheme that will provide you with higher returns than what you are paying on your mortgage debt repayment. You can easily manage your debt while accumulating wealth this way.
    

What are the disadvantages of a floating interest rate?

 
The interest rate in a floating interest rate fluctuates, as does your EMI. For example, if you pay Rs 20,000 in EMIs for the first 28 months of your loan term, you may be required to pay Rs 36,000 beginning in the 29th month. The uncertainty about how much EMI you will have to pay each month makes budgeting difficult and increases the likelihood of EMI delays, which ultimately harms your credit score.
 

What is the difference between a floating and a fixed interest rate?

 
Now that you understand the intricacies of floating and fixed interest rates, take a quick glance at the key differences between the two.
 

Parameters	Fixed Interest Rate	Floating Interest Rate
Affordability	They are slightly higher than floating mortgage rates.	Floating interest rates are usually 1-2% cheaper than fixed rates.
Budgeting	Budgeting is easier when you are aware of your monthly obligations.	Fluctuating EMIs complicates budgeting and increase the likelihood of EMI skips.
Foreclosure charges	If you want to pay off your fixed-rate mortgage early, you will have to pay a prepayment penalty.	According to RBI guidelines, you are not required to pay foreclosure charges on a floating-rate mortgage loan.
Suitable	It is best suited for a mortgage loan with a repayment tenure of 3-5 years.	It is ideal for mortgage loans with a repayment term of 10 years or more.

 
Also Read: Quick Guide to Mortgage Loans
 

To conclude

Both fixed and floating interest rates have advantages and disadvantages. A mortgage with a fixed rate of interest allows you to effectively plan your budget and reduces the possibility of EMI skips or delays. On the other hand, floating rates are ideal for those looking for a long-tenure loan against property. They are typically 1-2% less expensive than the fixed rate.