A fixed-rate loan provides stability and certainty, but borrowers may lose out if interest rates fall.

Choosing a fixed rate loan may appear to be the prudent thing to do, if only to protect oneself from market changes.

Fixed or floating interest rates

With news of banks slashing interest rates frequently making headlines recently, house loan customers are torn between switching to a fixed rate loan at current rates and continuing to float interest at market rates. A fixed rate naturally provides a sense of security and stability, especially for long-term commitments such as home loans. However, it comes at a cost. If interest rates fall more, you will be locked into a higher rate.

Previous rate variations

Opting for a fixed rate loan may appear to be the prudent thing to do, if only to protect oneself from market volatility, but there is an element of uncertainty regarding the route lending rates may go in the future. Rates had risen from the 7-8 percent level in the mid-2000s to 12-13 percent in 2009-10, with a trend reversal already developing in the current year. In such a case, determining whether to go with a fixed rate loan is a difficult decision.

Furthermore, because a house loan is a long-term commitment, even if expert estimates portray a situation a year or two ahead, this may have little influence on your overall loan rate, given that you have 10-20 years of payback ahead of you. Here are a few things to think about before making that crucial decision.

When should you take out a fixed-rate loan?

You are happy with your existing EMI: If your current EMI is less than 35-40% of your monthly salary, repaying your loan will be a breeze. You may consider locking your rate at this level to avoid future rate spikes that could disrupt your finances.

You desire assurance during the loan's initial term: Given your other financial obligations, if you cannot afford any additional rate rises in the coming years, a part-fixed-part-floating-rate loan with a fixed rate for the first 3-5 years and a variable rate beyond that is for you.

You anticipate that interest rates will rise soon: If you believe that market conditions may cause interest rates to rise in the future, which is currently improbable, you should opt for a fixed rate.

You do not intend to prepay the loan: If you do not intend to prepay the loan and service it for a lengthy period of time, it is always best to pick a fixed rate when interest rates fall. If you acquire a favourable rate on a fixed loan, this may help you lower your interest outflow in the long run.

When to avoid a fixed-rate loan

You intend to return the debt early: If you plan to make part-year prepayments or close the loan within 5-7 years, you can keep the variable rate. This is due to the fact that the quicker you close the loan, the lower the interest outflow. As a result, rate swings have less of an influence on your loan as a whole.

You can manage rate fluctuations: If you can manage your EMIs despite fluctuating rates, a fixed rate is not necessary. This is true if your EMI is less than 35% of your pay. Because fixed rates are frequently higher than popular variable rates, managing a fixed rate loan may be problematic in such instances.

If your loan is projected to be paid off in less than ten years, or if you have chosen a short-term loan, you do not need to choose a fixed rate. The interest outflow is lower for short-term loans. Furthermore, as your loan matures, your EMI will increase feed the principal component, lessening the impact of shifting interest rates on the interest component.

You expect interest rates to fall more: If you expect interest rates to fall further in the current circumstances, it is preferable to use a variable interest rate. When banks become more competitive in a downward trend, you may be able to acquire a better fixed rate offer later.

Keep in mind that not all fixed loans are fixed, and there is normally a cost for converting from floating rates to fixed rates.

Also, switching to fixed may be a smart idea if the rates are in the single digits or if the difference between floating rates and fixed rates is 1% or greater. In sum, there is no clear solution to the fixed rate conundrum. Much relies on your preferences and financial situation.

The hi-low effect

Choosing a fixed rate loan may appear to be the prudent choice, but there is some uncertainty about where lending rates will go in the future.

Rates had risen from the 7-8 percent level in the mid-2000s to 12-13 percent in 2009-10, with a trend reversal already developing in the current year.

Furthermore, a house loan is a long-term commitment, so even if expert estimates depict a picture a year or two ahead, it may have little impact on your overall loan interest.

If the rates are in the single digits or the difference between floating rates and fixed rates is 1% or greater, switching to fixed may be a wise move.

All fixed loans are not fixed, and converting from variable to fixed rates typically incurs a cost.

Also, while choosing a fixed rate loan, a lot relies on the borrowers' preferences and financial situation.

Other informative and important articles to read:

Higher price for your house in a market

What is home equity and why it is important

What is Moratorium and what should the borrowers do?


 

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