Floating Interest Rates on Home Loans

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Decoding what is floating interest rate on Home Loan & its many benefits.

Key Takeaways

• Floating interest is the commonly preferred interest rate lenders levy on Home Loans.
• The floating interest rate is based on the index or benchmark set by RBI.
• The benchmark considered is MCLR rate that is influenced by the repo rate indicating the flow of money in the market.
• Besides the benchmark, the spread applied by the banks also affects the floating rate.
• Floating interest rate benefit include lower interest, no prepayment charges, easy availability, flexibility, and transparency.

Buying a house is a monumental decision that often shapes your financial future. Perhaps the most expensive of all, it is an investment that keeps on giving. However, with the rising real estate rates, most people do not have the funds necessary to purchase property with their savings. But with Home Loans, insufficient finance is no longer an issue.

You can borrow the required amount to buy or build your dream house. In return, lenders charge an interest rate on the borrowed funds that you can repay in flexible, Equated Monthly Instalments (EMIs). The most commonly preferred type of Home Loan interest rate is a floating interest rate. Let us understand its meaning and benefits in this article.

What is a Floating Interest Rate?

A floating interest rate is a type of interest rate that moves in tandem with an index or benchmark that the Reserve Bank of India (RBI) sets. The benchmark or index used is the external benchmark or Repo Rate, i.e., the minimum rate at which banks are allowed to lend. The Repo Rate is reset at once in three months. The reset date is fixed on the 7^th of each calendar quarter, and reset four times a year, i.e., on the 7^th of January, 7^th of April, 7^th of July and 7^th of October.

Besides the benchmark based on RBI Repo Rate, the spread also determines the floating rate. The spread is the amount that banks add to cover their profit markup, credit risk, and other aspects of their lending policies. The amount of spread may differ from lender to lender, but it typically remains constant over the loan tenure.

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Benefits of Floating Interest Rate Home Loans

The major benefits of a floating interest rate Home Loan are as follows:

1. Lower interest rate:

   While the floating Home Loan interest rate varies based on the lenders and their spread as per their business strategy and credit risk, it is still on the lower side. The Repo Rate plays a huge role here, as favourable market conditions can lead to a lower benchmark. However, it may also fluctuate and increase during the loan tenure due to the changing market conditions.

2. No prepayment penalty:

   The Home Loan tenure ranges anywhere between a few years to decades depending on the flexibility you want in terms of loan repayment. However, with floating interest loans, lenders typically do not levy a prepayment penalty. Thus, you can become debt-free at a quicker pace. Doing so boosts your credit score, allowing you to easily borrow funds in future when needed.

3. Availability:

   Most lenders offer floating interest rate Home Loans. Hence, you need not actively shortlist lenders with a floating rate. You can get the details about the applicable interest rate while studying the Home Loan terms on the lenders' websites. You can also contact their customer care portal and get clarity on applicable interest rates.

4. Flexibility:

   As the interest rate fluctuates periodically with the floating interest rate, it leaves room for you to adjust your EMI payments. Moreover, you can pay extra EMIs using your bonuses and variable income. Such flexibility allows you to better manage your EMIs and repay your loan before the stipulated repayment tenure ends.

5. Transparency:

   As the floating rate of interest is linked to the repo rate that is set by the RBI, there is no scope for arbitrary rate changes. You can check the RBI-regulated rates to gauge the applicable interest payable. The same goes for fluctuations you may notice in the interest rate throughout the loan tenure. The only aspect that you will need to compare among lenders would be based on the spread they add to the benchmark rate.

Final Note:

Given the many benefits of floating interest rates on Home Loans, you can take advantage of the fluctuating market conditions when the economic environment is favourable. At the same time, you should be prepared to brace market volatility and pay a higher interest rate during recessions and economically-uncertain times.

It is thus vital to understand how Home Loan interest rates work. Also, keeping a check on the repo rate and MCLR rates helps you plan your Home Loan repayment. Remember to weigh the pros and cons of floating interest rates on Home Loans before choosing a floating rate loan.

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*Disclaimer: This article is for information purposes only. We recommend you get in touch with your income tax advisor or CA for expert advice.