One of the hardest decisions while considering a loan is to decide the better ones among fixed rates and variable rate of interest. If you too have often wondered what it is all about, this article would serve your purpose. We would try to find out various kinds of rate of interests available in the market and help you make the correct choice.
What is Fixed interest rate Loan
If you are getting a loan with fixed rate of interest, the rate of interest would remain the same throughout the term of the loan. This means that if you have agreed an ROI of 10.25% for a loan for 10 years, the rate would remain 10.25% for the next ten years. Fixed rate of interest is usually 1 to 2.5% higher than the floating rate of interest.
What is Resettable Fixed Rate Loan
This is yet another type of fixed rate of interest in which the rate is fixed for few years, i.e. 3-5 years. After this period is over, the rates are further revised and they continue for another 3-5 years. This type of rate is often subject to change in the market rates and is always a smart choice.
What is Floating Interest Rate Loan
If you want a variable, flexible and adjustable rate of interest on your loan, floating rate of interest would best apply in your case. As we all know, the market lending rates fluctuates regularly. Floating rate of interest is based on market lending rates and is thus know as floating rate.
This kind of rate is often a right choice but can turn out to be a pure gamble if the market lending rates go high suddenly. If the economy is not doing well, market lending rates are certain to go high and thus the floating rate of interest increases.
One of the main reasons why people choose floating rate of interest is that this kind of interest is often a little lesser than the fixed rate of interest and most of the times lesser than the market lending rates.
Partly floating and partly fixed interest rate loan
If you want the right blend of fixed as well as floating rate of interest, party floating and partly fixed rate of interest would best suit your needs. This type of interest rate is often termed as split rate, fixed-cum-floating rates, dual rate loans or fixed first rates.
How it works is that the loan amount if broken into two parts. On one part, a fixed rate of interest applies and on the other part, floating rate of interest applies. The borrower can decide the ratio in which the loan would be divided for fixed and floating rate application.
Not only the amount can be broken into parts to be applied as fixed and floating interest, but the total tenure of the loan can also be bifurcated. This way, a fixed rate would be applied on one part of the loan tenure and floating rate would be applied for the other part of tenure or vice-versa.
Advantages and Disadvantages of Fixed Interest Loan
There is something called historical rate of interest in India. If the current fixed rate of interest is lesser than the historical rate, it is always beneficial to go for fixed rate of interest. The historical rate of interest is the average rate of interest for over a period of more than 20 years.
If again, you are a safe player, it would always be better for you to go with fixed rate of interest. You never know what the economy may turn out to be and the rate of floating interest may increase abruptly.
As a matter of fact, fixed rate of interest is less prevalent in India as most of the rate of interest offered by banks claiming as fixed rates are actually resettable rate of interests.
One of the remarkable disadvantages of fixed rate of interest is that if the current rate of interest is higher than the average rate, you might lose a significant amount of money. Moreover, banks usually charge a 2 to 5% of prepayment penalty of loans with fixed rates since they cover the risk of rate of interest change.
Advantages and disadvantages of resettable fixed interest rate loan
In resettable fixed interest rate loans, you have more control over the rate of interest than compared to the case with floating rate of interest. This becomes more relevant if you are going to prepay your loan or if you plan to sell your property soon after you buy.
Advantages and disadvantages of floating rate of interest loan
As far as home loans in India are concerned, floating rate of interest is the favorite and most preferred choice. This is because the rate of interest in this case keeps increasing and decreasing as per the general market rates.
In cases where the general interest rates have decreased and the borrower has been paying the same EMI, the tenure of loan in reduced. There are many advantages of floating rate of interest. These are often lower than fixed rate of interest, as the entire risk is being covered by the borrower.
Floating rate of interest is always beneficial for loans that have longer tenure. And there are research studies to prove this.
Advantages and disadvantages of fixed cum floating rate of interest
If you are looking for interest rate diversification, this type of rate of interest would suit your expectations. However, loans under this type of interest rates are only good when the current rates of interests are at their historical low. Otherwise, it could be a costly affair altogether.
Last but not the least, choosing the best type of rate of interest is a matter of individual choice and specific requirement. If the current rate of interest is significantly low, choosing fixed rate of interest is always better. On the other hand, if the current rate of interest is comparatively high, choosing a floating rate of interest would do the best for you. The resettable rate of interest falls on the middle line among the former two types.