Is It Good To Switch To A Fixed Rate Home Loan When Interest Rates Are Rising?
I took out a floating-rate home loan three years ago. The popular interest rate is 6.75%, but I’ve been told this could go up soon as interest rates are going up. Should I switch to a fixed-rate home loan now? That way, I can avoid the price increase.
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(Question answered by Raj Khosla who is the Managing Director at MyMoneyMantra.com)
The main difference between fixed and floating rate loans is who bears the interest rate risk. In a floating rate loan, the borrower bears the risk if interest rates rise and is rewarded when they fall. In a fixed-rate loan, the lender bears the risk. To offset this risk, lenders charge a 75-100 basis point higher interest rate on fixed-rate loans.
The common interest rate on floating-rate loans is around 6.5-7%, while fixed-rate loans have a fee of 7.5-7.9%.
It’s true that home loan interest rates could rise in the coming months. Current rates are very low and if the RBI raises rates to control inflation, home loan rates will obviously increase. So it might make sense to switch to a fixed-rate home loan now.
But before you switch, calculate how much you could earn from switching to a fixed-rate loan. As mentioned earlier, fixed-rate loans charge a higher interest rate, so your equivalent monthly installments (EMI) will increase after the conversion. If the difference is more than 100 basis points, it may not result in any real savings for you as floating home loan rates may not increase as much. Remember that you will also have to include processing fees and other refinancing fees when you transition to a new loan.
Most importantly, read the fine print carefully when you make the conversion. Many loans are just fixed-rate home loans, where the interest rate is fixed for the first 2-5 years, after which they become floating-rate loans.
Interest rates could rise in this inflation scenario, but home loans are long-term contracts and eventually interest rates are likely to stay moderate as inflation cools.
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