Wealth creation is an art, people acquire and master throughout their life. And when in India, the economy is bending towards middle-class to offer you a taste of wealth in terms of property, car or bundles of white-goods, finance companies are standing in queue to back your good old dreams. But rate of interest is a matter of concern of course and thus what kind of interest rate should you opt for irrespective of the kind of loan?

While fixed rate of interest is determined by the Prime Lending Rate by the finance companies, floating rate of interest is normally fixed on last auction rate of 91-days government treasury bill. Prime Lending Rate or PLR is governed by the RBI’s regulation whereas floating rate of interest is the reflection of country’s inflation scenario. But, for general people like you and me, it is not easy to understand. Wealth creation demands discipline in due course of time which is available with fixed rate of interest and thus fixed rate gives you the liberty to plan your future systematically. As floating interest rate is a kind of unsystematic risk for us, it is better to avoid this.

Let us discuss the issue with housing finance loan. The southward movement of interest rate may tempt you to consider all the options to buy a house or purchase a land. As a result of the periodic fluctuation of interest rate- both upward or downward, some banks like HDFC started offering the Adjustable Rate Home Loan (ARHL) facility to enable the well-informed, market savvy customers to take the benefit of interest rate movements. But, that includes the potential risk of increase in the interest rate over a period of time.

Let us assume, you are planning to take a loan of Rs 12 lakh with a tenure option of 15-20 years and want to exercise different options to make your final move. Say, the rate of interest is 12.5 per cent per annum for both fixed rate and floating rate of interest. Your calculation could be:

Therefore, you can easily understand how to plan your monthly budget to meet your EMI requirements and you can also calculate the cost of the loan when you will avail the fixed rate of interest. But, you can not do so, if you are looking for floating rate of interest.

In case of floating rate of interest, the rate of interest is revised generally in every six months from the date of first disbursement, if there is a change in PLR. However, the EMI on the will not change. For instance, if the interest rate increases, the interest component in EMI will increase; the principal component would reduce, resulting in an extension of the term of the loan and vice-versa when the interest rate decreases. You will be provided with an annual statement indicating the details of the interest and principal payments made during the year. And, ultimately, you need to plan your budget with an uncertainty in this floating rate of interest that is not a good move to plan your wealth.

Many people are of opinion thus that, floating rate loans are not suitable in Indian conditions, since they do not give customers any planning options. Secondly, interest rates have come down in the recent past, there is a little likelihood that rates will fall to 3-4 per cent more. And study shows disbursements with floating rate of interest accounts for only one percent of the total loan disbursement in general. People prefer fixed rate of interest as they can work out their finances for the period of the loan more comfortably.

Once one finance company advertised "we can loan you enough money to get you completely out of debt" but be cautious before you take a final decision. Better to create the wealth with discipline than to create at the cost of uncertainty.

Feedback

Rate this article