Thinking of buying a house and confused whether to opt for a floating-rate home loan or a fixed-rate one? With interest rates likely to head south in the next few months, a floating rate makes more sense, say financial planners.

Typically, lenders have a tendency to push fixed-rate home loans when the interest rate cycle is on the downtrend. But financial planners suggest that floating rate home loans are more advantageous.

In a floating rate cycle, interest rates vary in sync with the base rate of the bank. In a fixed-rate loan, as the name indicates, the customer locks in on a specific interest rate and continues to service the instalment at those rates.

In his fifth bi-monthly policy review on Tuesday, RBI Governor Raghuram Rajan indicated that the central bank and the Centre are trying to set the economy on a low inflation path over the next two years or so.

Lower rates If that happens, then it might not be far-fetched to assume that policy rates will be lowered. Banks will then lower their interest rates, benefitting the floating rate borrower.

For instance, a large private sector bank charges a salaried borrower a fixed rate of 10.25 per cent for loans up to ₹1.5 crore, whereas its floating rate loan varies between 10.15 and 10.25 per cent. The floating rate borrower will benefit when the interest rate goes down but the fixed-rate borrower will have to continue to service his instalments at 10.25 per cent.

According to Suresh Sadagopan, Certified Financial Planner and Founder – Ladder7 Financial Advisories, “There is no sense in opting for a fixed rate product at a time when interest rates are likely to come down due to lower inflation.”

Prepay If at all a consumer opts for a fixed-rate product, he adds, then he or she must look at banks which offer fixed rate loans closer to the base rate.

But given the tendency of a lot of Indian borrowers to prepay their home loans, they must opt for a floating rate product to reap the benefits of a possibly benign interest rate regime in the near future.

Risks, however, remain as the interest rate cycle could reverse. As the governor aptly put it, “inflation is not a one-way street.” Potential risks could emanate from weak monsoons in 2015 and beyond, crude oil prices climbing again from the current levels of about $70/barrel and a sharp spurt in demand along with the expected growth over the next few quarters.

However, according to Malhar Majumdar, a Kolkata-based financial planner, “In the long run, I would still advise my clients to take a floating-rate home loan.”

Although the consumer will benefit from the downward movement of interest rates over the next couple of years, he feels that this will get offset if and when the interest rate cycle reverses. A lot hinges on how long the RBI and the Centre can keep the inflation cycle lower. For this to happen, the country would need more structural reforms.

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