Comparing Mortgage Loan Types: Fixed Rate vs. Adjustable Rate Mortgages

A thorough knowledge of different financial aspects is necessary to choose a favourable mortgage loan that meets your requirements suitably. One of these aspects is the types of interest rates. For every prospective borrower, interest rates are the most crucial factor, especially when it is a long-term debt, like a mortgage loan (home loan, loans against property, etc.), as it determines the affordability of a loan. Therefore, it is crucial to pay attention to the types of mortgage interest rates. 

Lending institutions offer mortgages with two types of lending rates – fixed and adjustable interest rates. Let us help you to compare the two interest rate types before you make an online mortgage loan application.

Understanding Fixed Interest Rate Mortgages

• A fixed-rate mortgage represents obtaining a loan at a fixed interest rate that remains the same for the entire loan tenure. Resultant, the EMI (Equated Monthly Instalment) during the loan repayment term remains equal. 

• Since interest rates remain constant throughout the entire tenure, it is easy to determine the monthly instalments for a fixed rate mortgage using a property mortgage loan calculator. However, there are variants available for fixed-rate mortgages. Lenders may offer a mortgage at a fixed rate for a certain period, say two or three years, during the tenure. The borrower can negotiate for the lock-in period to fix the interest rate for a specific period. 

Understanding Adjustable Interest Rate Mortgages

Adjustable-rate mortgages are referred to as loans offered at floating rates. The interest rate on these mortgages fluctuates during the loan tenure, reflecting economic or financial market conditions, as they are linked to the Marginal Cost of Lending Rate (MCLR) or lender’s benchmark rate. 

In simple words, rates on these mortgages are synced with changes in market conditions and the Reserve Bank of India’s (RBI) repo rate (one of the external benchmarks). 

If RBI increases the repo rate to reduce liquidity in the economy or vice-versa, the interest rate on adjustable-rate mortgages will increase. Therefore, it can be risky or rewarding depending on how the economy or market conditions change over time. 

Generally, lenders reset adjustable interest rates on mortgages at specified intervals, like quarterly, half-yearly, or annually. Also, it can be unique for different customers. If the market rate changes during the applicable review period or reset cycle, loan rates also be reset. 

Key Differences – Fixed Rate vs. Adjustable Rate Mortgages

Considering these differences between fixed and adjustable rate mortgages, customers can understand the pros and cons of both rates and make an informed decision on their home loan or loan against property:

• Affordability 

Adjustable-interest rate mortgages are slightly lower than fixed rates. Since the lending rate remains the same throughout the repayment tenure and the lender cannot change interest rates even if the repo rate increases, fixed rates are usually a notch higher than adjustable rates. Adjustable-rate mortgages benefit borrowers with repo rate cuts. Also, adjustable lending rates benefit them with zero prepayment charges, unlike fixed-rate mortgages. This benefit is not offered with fixed-rate mortgages. 

• Preplanning

Adjustable interest rate mortgages are a bit unpredictable because borrowers do not know the level of interest rate change during the review period. On the other hand, fixed rates give borrowers a sense of certainty with the monthly mortgage loan instalment along with the total interest outgo. Simply because they know their monthly obligations right from the start of the loan tenure. They can easily plan their finances using an online property mortgage loan calculator.

• Simplicity 

Fixed-rate mortgages are indeed easy-to-understand and straightforward loans as the interest rate remains constant for the entire repayment term of a mortgage loan regardless of any external factors (economy or market conditions). Borrowers need not worry about the impacts of fluctuations in interest rates on the borrowing cost. On the other hand, adjustable-rate mortgages are complex as the instalment amounts change with the change in market conditions.

Should One Opt for Fixed Rate or Floating Rate Mortgages?

The choice or suitability of fixed and adjustable rate mortgages differs in different scenarios. 

Fixed-rate Mortgage suitability –

• Borrowers prefer fixed-interest rate loans if they are comfortable repaying the mortgage with the same amount of EMI during the entire tenure. 
• If experts sense a rising interest rate scenario in the future, borrowers may prefer a fixed-rate mortgage to save on interest costs.
• If the borrower wants to plan their finances beforehand, they may choose a fixed-rate loan.

Adjustable-rate Mortgage suitability –

• Borrowers may consider an adjustable-rate mortgage if the base rate is expected to reduce over time. It results in savings on interest costs.
  

Thus, individuals can look at the key differences between fixed and adjustable-rate mortgages to decide on a mortgage. Consider varied scenarios to understand the suitability of fixed or adjustable rate mortgages.