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Which type of loan is best, a Fixed interest rate or a floating interest rate?

In India most banks offer mortgages that start with a 12% floating rate or a fixed rate mortgage with a 13.5% interest rate.

Could you help me understand how to tell which type will be the best choice?

  • It depends on way too many factors for an answer to your question as phrased. What's the fixed period? What happens to the loan at the end of the fixed period, if it's shorter than the duration of the mortgage? Are there early redemption penalties? Can you afford to pay a higher rate if rates go up? What's your attitude to financial risk? What are your expectations for interest rate changes over the lifetime of the fixed rate? – Mike Scott Mar 28 '12 at 9:01
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Under the current circumstances in India, its hard to predict whether a Fixed Home loan is better or Floating is better.

On hind site in year 2003-2005, the fixed rate was around 8.5% and floating was around 7% to 7.5%. While the floating rates have gone up to 14.5% for the same customer who took the floating rates at 7.5%, while those who took fixed at 8.5% stayed there. Till 2010 the floating rates by Banks were internal rates and not pegged to RBI indexes. Hence it was common for Banks to raise the floating rates of older loans, and issue new loans at lower rate.

If you go back further during 1998-2000, the fixed was around 13% - 15% while the concept floating had just started and was around 11.5% to 12%. If you had a floating rate, you would have actually seen rates go down to around 8.5% before rising.

By 2005-2006 most Banks had stopped fixed rates. All the rates that were advertised fixed had quite a few exit clauses like fixed for 5 years and then revised every 3 years, or will be changed if there are unforeseen changes, etc.

Even today I am not aware of any Banks offering fixed rate for life of the loan without any hidden riders. If you can point me to specific institutions, I can comment better. The practice of fixed may have started again as rates are at all time high right now and will only move down.

Factors that will help you determine which one is better;

Fixed rate:
- You outgo is constant and you can plan. Even though you feel that you are paying more, its assures you a fixed payment you can make. - On floating rate, I have seen quite a bit of movement that has resulted in EMI being doubled and putting undue strain on the finances as Salary did not go up in tandem.
- Overall you believe that the rates would move up on average. [However currently the rates are at all time high and are likely to move down]

Floating:
- If you believe you cannot afford the EMI now, but anticipate huge changes in salary so that you are covered if and when the rates go up.
- Floating Rates are today better regulated by RBI and Banks cannot resort to the practice of hiking rates on older loans and keep the new one artificially low.
- The formula to be used ensures that the rate will go down if RBI rates go down.
- Good if you are anticipating rates are going to go low in future.

  • Is it possible to do Mortgage refinance from my current fixed interest rate plan with same or some other bank – vinoth Mar 29 '12 at 4:36
  • @vinoth: It is possible to refinance your loan from fixed to floating from same or different institution. Although RBI has now issued a guideline to not charge a penalty for Floating to floating [or fixed]; Banks are still free to charge a penalty [typically around 2-4% of outstanding principal] for converting from Fixed to Floating [or Fixed]. – Dheer Mar 29 '12 at 5:09
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Caveat: I know nothing about the banking system in India. However, based on what I have seen here in the US, you are almost always better off with a fixed rate due to the stability it provides, and if rates go down, you may be able to refinance with another bank if your current bank won't work with you (in the event rates go down).

The risk you take with a floating rate (which sounds an awful lot like our adjustable rates here) is that you could end up with a higher rate in the future and then all of the money you "saved" by having the lower rate earlier is gone after a period of time.

Money is one of the areas in life that I try to avoid having too many surprises and I can not imagine waking up and having my shelter expense go up and not being able to do anything about it. I would go with the fixed rate.

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