Should You Opt For A 1 Year Fixed Interest Rate Home Loan Or A 3 yr Fixed Interest Rate Home Loan
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In a bid to woo customers, many lending institutions have brought out attractive home loan schemes, for example, SBI Easy Loan with a fixed interest rate of 8 per cent for the first year. But how can one decide whether these schemes are really beneficial? Well, the actual benefits in a home loan are known by how the interest will be calculated on it. Interest on a home loan is calculated in various manners, one of them is the one used for loans having the rate locked in for a period. Different loans have different lock-in periods for rates, but the common ones are one year and three years. Let us now compare these two on the basis of actual benefits available.
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Surety and stability
The lock-in nature of the interest rate provides a kind of stability to the rate.Highlights- Actual benefits are different for different lock-in periods
- There is low risk and higher stability in a 3-year loan
- A decrease in rates will be more beneficial in a 1-year loan
For one-year loan
In this case, the surety and stability will be only for the first year, after which the loan rate will be different. The most important thing here is since the lock-in period is short the borrower has to keep an eye on the developments in the interest rates. These developments will impact the actual rates once the lock-in period is over and decide future trends for the loan.For three-year loan
This type of loan is meant for risk-averse people as it provides a higher amount of surety and stability due to a longer time period. In this offering, immediate rate changes do not have much of an impact on the borrower.Volatility
Floating rates are volatile in nature. If a borrower chooses floating rate option after the end of the lock-in period, he/she has to face with this problem too.For one-year loan
In this case, the rate changes will immediately affect a borrower. This means a borrower has to face the volatility in the loan for a longer period of time. The extent of the volatility depends upon the level at which the interest rate is fixed and if the first-year fixed rate is far lower than the market rate then suddenly the change could be large. For example, a bank offering a first-year interest rate of 8.5 per cent against the market rate of 10.75 per cent, then after one year the loan will carry the prevailing market rate (let us assume it is 11 per cent), which means a jump of 2.5 per cent for the borrower.For three-year loan
For the first three years, the volatility is absent in this case but the sudden change that comes after that could be large in case the interest rates move in upward direction.Linking
There will be a difference in the manner in which the floating rate loans are considered.For one-year loan
The one-year fixed rate loan is likely to have a favourable relation to the benchmark floating rate of the bank, which means a lesser difference. For example, the loan with a one-year lock-in might be priced at 1.5 per cent below the benchmark rate by a bank after the lock-in period is over.For three-year loan
A bank may not adopt the same lenient approach and price the interest rate below the benchmark rate as it would like to safeguard its own position. In this case, the bank could fix the rate after three years at 1 per cent below the benchmark rate, which can result into a higher overall rate for the investor.
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Benefit to flow down
The real benefit for the borrower will come in when there is a lowering of the interest rate, as this will mean a lower payout.For one-year loan
There is a higher chance that the rate could be similar or at an even level in the next year if there is a favourable movement in the market.For three-year loan
The above situation might not be present in this case because here a favourable movement (decrease in the rate or maintaining the same rate) in the first or the second year will not be applicable for an interest rate benefit. In most cases, the second- and third-year rate is higher than the first year, so during this time a positive movement of the interest rates will not benefit the borrower. A later movement would then be required for the actual benefit to come in.Published on May 6, 2010 · Filed under: Home Loan Articles; Tagged as: fixed cum floating interest rate, fixed interest rate, floating interest rate, home loan processing fees, interest rate
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