I took out a variable rate mortgage three years ago. The current interest rate is 6.75%, but I’m told this may soon rise as interest rates rise. Should I switch to a fixed rate mortgage now? This way, I can avoid rising rates.
–Name masked on request
(Query answered by Raj Khosla is Managing Director of MyMoneyMantra.com)
The main difference between fixed rate and variable rate loans is who bears the interest rate risk. In a variable rate loan, the borrower assumes the risk if rates rise and is rewarded when they fall. In a fixed rate loan, the lender assumes the risk. To compensate for this risk, lenders charge 75 to 100 basis points higher interest on fixed rate loans.
The going rate for variable rate loans is around 6.5-7%, while fixed rate loans charge 7.5-7.9%.
It is true that mortgage rates are likely to rise in the coming months. The prevailing rates are very low and if the RBI raises the interest rates to control inflation, the mortgage rates will obviously rise. It may therefore be wise to switch to a fixed rate mortgage now.
But before you switch, calculate how much you stand to gain by switching to a fixed rate loan. As mentioned earlier, fixed rate loans charge higher interest, so your monthly equivalent payments (EMI) will increase after the switch. If the difference is more than 100 basis points, you may not see any real savings because floating rates on home loans may not increase as much. Keep in mind that you will also incur processing fees and other refinancing fees when you switch to a new loan.
Most importantly, read the fine print very carefully when making the change. Many loans are just quasi-fixed rate home loans, where the rate is fixed for the first 2-5 years, after which they become variable rate loans.
Interest rates may head higher in this inflationary scenario, but home loans are long-term contracts and ultimately interest rates are likely to moderate as inflation cools.
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