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Those who opt for home loans they usually face a problem of whether to choose for fixed rates or floating rates. It is so because most of them neither know the accurate character of fixed rates and floating rates nor they know the differences between them.
What is Fixed or Floating ROI on home loans
Fixed rate home loans are loans available with a fixed rate of interest for a given period of time.
While Floating rate home loans are linked to the prevailing market rate of interest
Features of Fixed rate Home Loans
- The fixed home loans depend upon the duration of the loan.
- There are generally two types of fixed loans.
For 3 years
- Here, the rate of interest is fixed for the first three years after which it may change depending upon the market.
- At the end of the 3 -year period, the interest rate could be associated with the prevailing interest rates at that juncture.
Pure fixed rate
- There has also been a third one known as "pure fixed rate" in which the rate of interest remains the same without any change throughout the tenure of it.
- However, as the rates fluctuates rapidly in the market, not many house financing companies (HFC) offers such type of a loan.
Features of Floating rate home Loans
- Floating rate home loans are associated to the existing market rate of interest. Floating rate loans henceforth changes regularly on a specified time basis.
- Generally, the change in the rate occurs in every quarter of a financial year. However, this is not a fixed rule.
- The time period can differ from a HFC to another HFC. A certain HFC can change the rate biannually or even annually.
A floating rate loan has three parts
- Effective rate (which is the actual interest rate applicable to a loan.),
- Benchmark rate (which is normally a little lower or higher than the actual rate)
- (3) Mark up or mark down (which is the difference between the benchmark rate and the actual rate).
Benefits
- Banks and other HFCs may prefer to lend to their customers with floating rates, since they are raising funds (through deposits, bond issues, and by borrowing from other banks or the money market).
- Setting a price for loans to their customers in the same coins and foundation allows banks to have an efficient administration of the sense of balance between their assets and liabilities.
- Characteristically, floating rate loans may cost less than fixed rate loans.
- This depends on part on the yield curve.
- In other hand for paying a lesser loan rate, the borrower takes the interest rate: the danger that rates will escalate in future.
- In those cases where the yield curve is inverted yield curve, the asking price of borrowing at floating rates may actually be higher.
- Though in most cases, however, lenders want higher rates for longer-term fixed-rate loans; because they are always have the interest rate risk (risk that the rate will escalate, and they will get lesser interest revenue than they would otherwise be having) with them.
- It has been seen that the divergence between fixed and floating rate is between 1.5 and 2%. If interest rates increase by less than 2%, customers of floating loan will have advantage from it.
Case Study
- Again as per today's scenario home loans are generally of long terms spanning over 20-25 years.
- If the growth rate of 8% (as of now) or above continues in future, incomes are going to escalate too. Therefore, the interest rates are expected to remain constant and low.
- So, taking into consideration of this fact and long term view, majority of customers are opting for floating rate of interest.
- Though it is still difficult to predict which way the interest rates will end up, 90% customers have preferred floating rate of interest rather than a fixed one.
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