What is the difference between fixed and floating home loans?

There are currently three types of home loans in the market i.e. floating rate, fixed rate and hybrid loans which are fixed for a period of time.

The interest rate you are charged on a floating home loan is specified as a deviation on a index rate, which will change due to changes in macro-economic factors such as decisions by the Reserve Bank of India. If the index rate increases, then your home loan interest rate will increase causing the tenure of your loan to be increased because banks try to keep your EMIs constant.Similarly if the index rate decreases, then your home loan interest rate will decrease causing the tenure of your loan to be decreased. Essentially in a floating rate home loan, the bank passes on the risk of macro-economic factors to the borrower. Over 90% of the home loans in India were floating rate home loans, until the launch of hybrid loans which are discussed below.

Fixed rate home loans offered by banks in India are not guaranteed to be fixed for the entire tenure of the loan. Fixed rate home loans offer you rates that are only fixed for a few years, after which the bank has the right to increase the rate at their discretion. Some points to note on fixed rate loans are:

1. The initial rate on fixed rate home loans is at least 2% more than that of a floating rate home loan.

2. When market rates decrease the rates of floating rate home loans go down passing on the benefit to the customer, however people with fixed rate home loans are not benefited. On the other hand when market rates increase the rates of both floating rate home loans and fixed rate home loans increase (This is because fixed rate loans have a clause which permits banks to increase the rate at their discretion after a few years).

From the above you see that in a fixed rate home loan, you pay a higher initial interest rate for the benefit of being shielded from the risk of rate increases but you are actually exposed to these risks anyway as the bank can reset your rate after a few years. Plus you do not get the benefit of falls in market interest rates. This is why fewer than 10% of home loans being disbursed in India are fixed rate loans.

Hybrid loans which offer you a low fixed rate for an initial period, which is reset to a floating rate after the initial period, have become very popular over the past year or so. One way to think of these loans is that they are the same as floating rate loans but offer you a lower fixed rate for the first few years. Until hybrid loans were launched over 90% of home loans were floating interest rate home loans, however hybrid loans have captured a huge share of the market over the past year.

Your home loan eligibility and home loan interest rate

You can use a home loan to (a) finance the purchase of a home that is either already built or under construction or, (b) to transfer your existing home loan from another lender or, (c) to purchase a plot of land and construct on it. Most banks offer home loans which can be repaid over a period of up to 20 years (15 years for NRIs).

The loan amount you are eligible for and the home loan

interest rate you will be charged are dependent on factors such as income, location, loan amount and the value of the property you wish to purchase. Banks typically limit the monthly payment (EMI) on your home loan to about 40% of your monthly income, and will also cap the overall loan amount to 85% of the value of your property

Typical fees and charges payable for a home loan

1.Lenders charge a processing fee of about 1% of the loan amount, but this fee is usually capped at Rs. 10,000

2.If you repay your home loan earlier than the agreed time frame, lenders charge a pre-closure penalty of about 3% of the pre-closed loan amount.

Comparing home loan quotes from different banks/NBFCs

1.Banks quote interest rates in many different ways (ex. monthly reducing rate, flat rate), hence just looking at the interest rate value alone might not give you a true picture of which home loan quote is the best. The processing fee should also be considered when comparing loan quotes. The best way of finding out which home loan quote is the cheapest is by comparing the total amount that you need to pay in order to completely pay off your home loan.

Total cost of home loan = Loan amount + Total interest charged throughout loan tenure + Processing fees & related taxes

2. Compare the customer satisfaction ratings of each bank, as you'll need to remain in contact with your bank for the period of your loan, which could be the next 20 years.

3.The amount you are eligible for will vary by bank, hence choose a lender who lends you enough for you to afford the down-payment on the house.