Introduction
Where you don't lock, but rather unlock the knowledge of finance. Whenever you for a home loan then you've two choices. Whether you can take fixed interest rates or floating interest rates. Now, which interest rates should you take? Which is better? Actually, there's not a straight answer for this. It depends on the market.
Contents
Whether the interest rates are going up or are likely to come down?
Interest rates will increase or decrease in the future?
Which you should take floating interest rates or fixed interest rates?
How do floating or fixed interest rates differ with different parameters?
We should choose a fixed interest rate or a floating interest rate?
We will also discuss the advantages and disadvantages of fixed interest rates and floating interest rates. So stay tuned to this video from beginning to end. So that you understand this concept clearly. Let's go straight to the blackboard. Before understanding that,
What are the differences between fixed interest rates and floating interest rates?
Let's understand that first. If I talk about definition first, So fixed interest rate definition is such that all your loan terms Suppose you take the loan for 20 years so that interest rates could be fixed for 20 years.
Suppose you take the loan at a 9% interest rate. So that 9% rate will be fixed for 20 years. Or else, part of the loan term Many times it also happens that it is fixed at 9% for 2 to 3 years and after that, it'll become floating.
So, in that case, it is fixed for 3 years and it is floating for the rest of the loan term. Right!
After that, If we talk about floating interest rate The floating interest rate fluctuates up and down as per the market conditions. for complete 20 years. If suppose you've taken a loan for 20 years then it'll go up and down during 20 years. At one time, suppose you've taken at 11% and then maybe it becomes 8% and let's say maybe then it will increase again to 11% like this way, the cycle will continue for 20 years.
As the market conditions will go up and down. Then the second difference between EMI and loan tenure. In fixed interest rates, your EMI and loan tenure are fixed completely.
Suppose your EMI is 30,000 according to fixed interest rates then it will be fixed for 20 years. You need not worry if you have taken a fixed interest rate for 20 years. After that, there's a slight difference in floating interest rates. In floating interest rate, suppose you belong to a younger generation.
Which is better-fixed interest rates or floating interest rates?
Suppose you've taken a loan in the age bracket of 21-40 years then you have a service time of more than 20 years. You've more than 20 years to service that loan, right! So what do banks do generally in that cakes?
They keep your EMI fixed but change your loan tenure. So what does that means? Suppose they fixed your EMI at 30,000 0nly and suppose interest rates increased It increases from 9 percent to 10- 10.5% So they will increase the loan tenure from 20 years to 21 or 22 years. As the interest rate increases your tenure also increases.
If your interest rate decreases your tenure will also decrease. But if you are in a higher age bracket Suppose you are 40 plus So there is not much scope to increase your loan tenure. Because you only have 20 years to service the loan so they won't increase the tenure to 21
What will the bank do in that case?
It may increase your EMI from 30,000 to 32,000 or 32,000. right? So here, you should pay attention
If you've taken the fixed interest rate then you've to keep a scope that if your EMI increases then you can also bear some burden So it becomes important to know this difference. If we talk about interest rates then you'll see, that the fixed interest rate will always be more. And on the other hand, the floating interest rate will always be lower than the fixed interest rate.
If I give you an example suppose you are getting a floating interest rate of 6.25% then you'll easily get a fixed interest rate of 8.8-8.9% It will always be 0.5 to 1% more than the floating rate. The second difference is the prepayment penalty.
If you'll choose a fixed interest rate, you may always have to give the prepayment penalty. Generally, the bank charges a prepayment penalty of up to 2% of the loan amount that you are going to pay.
So suppose, you made a prepayment of 2 lakhs then they will charge you Rs.4000 extra. So this is a slight difference in fixed interest rates. If suppose you want to move towards the floating from the fixed interest rate you want to transfer your bank towards a lower interest rate then you must have to pay these many charges.
Here I am talking only about 2 lakhs If suppose, this is 20 lakhs in the case of 20 lakhs, this amount will also be higher, it will be 40,000. So that's why you should be careful when choosing a fixed interest rate. Try that you don't have to pay this prepayment penalty. After that, if we talk about a floating rate then generally, there's no prepayment penalty.
What is the risk of a floating rate home loan?
It used to be earlier but now RBI has abolished it. On today's date, there's no prepayment penalty in the floating interest rate. Let's talk about lock-in now As we've talked about fixed interest rates, fixed cum floating interest rates also come up many times, there's a fixed interest rate of 2-3 years and then there will be floating interest rates after that. And if you are getting a fixed interest rate in a low interest for complete loan tenure then you can choose that also. You can also lock in your interest rates for up to 20 years.
Now, if we talk about floating interest rates then here also, a kind of lock-in is possible What happens in this?
You'll see that the new customers of any bank they'll always them the best interest rates. If suppose, new customers are getting at 8.25% your interest rates can be much higher, can be up to 9%. Right?
So what you can do in this case? You can lock in. This lock-in is possible in some banks There they claim that there won't be a difference greater than 0.25% between you and the new customer So what will happen in that case? Suppose your interest rate is 9% then it will go down maximum up to 8.5%, right! So you don't have to pay more than 8.5% So if you want the interest rate of the new customer, you've to pay conversion charges.
But if there's a difference of only 0.25%, then you don't need to pay these conversion charges. If your interest rate is 0.25% higher and you are not much affected by it then you can go with 8.5% as well.
So there is a major difference between floating and fixed interest rates. Let's understand the calculation now.
How to choose fixed interest rates or floating interest rates?
it's quite important to understand the economic cycle if you want to predict the interest rate. Let me write the percentage here and let me write the time here. And if we study the history of the last 15 years so if we study from 2003 to 2018 that how the interest rates and inflation has moved
So let me write 4% here And let's say I write 4% and 12% here So see, in 2003, inflation was around 4% and interest rates were about 8% After that, slowly- slowly, till 2008 interest rates got increased, right!
By 2008, the interest rate had risen to approx 11.5%. Alright? And inflation was about 4% in 2003. and it went up to about 9.5- 10 percent. So let me plot inflation here. After that, in 2009, it got crashed. The whole was crashed.
So, the interest rates came back down again to about 8.5 - 9 percent. So let me plot it here like this. And your inflations also fall down to around 5.5 - 6%. So let's plot inflation here. After that, again in 2003, the market peaked. So let me plot for 2013 again. Interest rates of home loans were again back to 11.5% It had grown like this. Inflation also rose to 9-9.5%.
How does inflation affect interest rates in 2022?
So let me plot inflation in this way. So this is about 2013, right! Let's talk about 2022 now.
In 2018, today, you are getting a loan at the rate of 8.15% as well. So, it came back down to 8.15%. And inflation also, in today's date, has come back down to 6.5%so it is somewhere here, right. let me erase it. alright!
So, you'll see...let me write down here there are your interest rates. Here I am talking about home loan interest rates. And mostly the other loans also follow this graph. And this is your inflation. Inflation means a general increase in prices. Inflation figures keep printing, so you can check them too.
So see, broadly interest rates are following inflation only. So whenever there's an economic slowdown The government generally, pushes the loan rates downward to give economic growth.
If interest rates are lower, more money will come into the market, and the business will grow more. So, slowly-slowly, interest rates start increasing if inflation starts increasing. If more business grows, then inflation also starts increasing. So interest rates always follow inflation, right!
So, let's see the history of 15 years that interest rates have generally followed inflation. When inflation had gone up, interest rates also rose. And as inflation decreased after that, the government thought that we should also lower the interest rates. And should increase business. So in this way, interest rates also fall down.
So whenever there's an economic slowdown, the interest rates will also fall down, And when the economic cycle blooms see where it hit the peak in 2008, the economic cycle was running at a peak. In 2009, suddenly a recession came so the government also decreased the interest rates.
In 2012-2013, the market again peaked even real-estate prices also peaked in 2012-2013. After that, real estate prices also fall down and all other prices also fall down. the government also decreased the interest rates because the government wants to increase the economic cycle and business.
When should we choose the fixed interest rates?
So we should choose the fixed interest rate when the inflation is at the bottom See, here the inflation was at 4% so we should've gone for fixed interest rates here. So if you would have taken a fixed interest rate here, at this time then you surely would have been in a great profit. In the same here, if you had taken it somewhere here ok then also you would have been in profit.
Now, in today's date also, the interest rates and inflation are at the bottom so if you take fixed interest rates here then you will be in profit. because now the interest rate may start increasing from here. So this is all about inflation.
Second, when the interest rates are at the bottom. The interest rates were at the bottom here. They were again at the bottom here in 2009. So it is directly linked to inflation. Inflation has fallen a lot so the market is at the bottom now, you can take a fixed interest rate now.
So whenever there will be an economic slowdown you'll always see interest rates fall down. And the fixed interest rate is better at that time. And whenever the market is at the bottom at that time, the difference between the floating and fixed interest rates increases.
So if I talk in today's date if you are getting floating interest rates at 8.25% So you'll see, that you may be getting the fixed interest rates at 8.8-8.9% This difference is quite high. So the banks will try to push the floating interest rates at this time Because they'll expect the interest rates to rise from there, right! So this difference could be around 0.6-1%.
So this difference will be very high. If suppose banks are pushing you too much to get floating interest rates they may be expecting the floating rates to rise, that's why they are pushing. This is a good indicator that you should choose fixed interest rates.
When you should choose floating interest rates?
When inflation is at its peak. See, here the inflation peaked at 9-9.5% So, at this time, you should have taken the floating interest rate, or even if the inflation rate has started decreasing a bit then also you can take a floating interest rate at that time. Because in the future, they will fall.
They started decreasing slowly in 2013, so at this time, you should always go for floating interest rates. So, whenever the cycle starts going downwards at such time, always take floating interest rates. You'll get to know about this cycle from both inflation and interest rates that now the cycle is going downwards. So, you should take floating interest rates at that time. So, similarly, there's an economic boom
So if the economy is booming, as it was during the economic boom in 2008 & in 2012-13 All the prices were at their peak. Markets were flourishing. You can also estimate by the share market if the markets are booming so it's a good indication for you. assume that now the market will also go down and the interest rates will also be lowered.
If markets are at boom then there are maximum chances that they will crash as the market crashes, interest rates will also fall rapidly, And after the market crashes, interest rates start increasing slowly. So when you'll understand these economic cycles you'll be able to predict in a better way, right! After that, as we've talked about fixed and floating interest rates if this difference is decreased.
How much difference comes interested between fixed interest rates and floating interest rates?
If suppose the floating rates are running at 11% and you may be getting the fixed interest rates at 11.3% So you'll think, let's go for fixed interest rates, there's isn't much difference anyway.
But when the bank is pushing much for a fixed interest rate that means he's expecting that the market will go down and the interest rates will also go down slowly So you shouldn't take fixed interest rates in such cases. When banks are forcing too much for fixed interest rates at that time you should take floating interest rates. See, if in 2013, you take fixed interest rates at 11 or 11.5% then you wouldn't have got this benefit. The benefit of 8-8.15%, which you are getting now, you wouldn't have got this. So in this way, if you can understand the economic cycle then you can very easily predict whether the interest rates are going to rise or fall take your fixed or floating interest rates according to that ONLY. I hope you understand this whole pattern. We've also seen the historical context. How are the interest rates and inflation-linked inflation-linked? and How do predict the interest rate will go up or down in the future?
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