The Pros and Cons of Fixed-Rate vs Adjustable-Rate Mortgages

If you plan to buy a home in India, one of the most important decisions you must make is choosing between a fixed-rate and an adjustable-rate mortgage. Both types of loans have their advantages and disadvantages, depending on your financial situation and preferences. 

But which one should you go for? 

This is where understanding the difference between fixed-rate and adjustable-rate mortgages and their pros and cons will be of great use. 

Fixed Rate vs Adjustable-Rate Mortgages: What are they?

Simply put, a fixed-rate mortgage is a loan where the interest rate remains constant throughout the entire term of the loan. This means that your monthly payments will also remain the same, regardless of the changes in the market interest rates. A fixed mortgage rate offers you stability and predictability, as you know exactly how much you will pay every month and how long it will take to repay the loan.

On the other hand, an adjustable-rate mortgage (also addressed as ARM, floating-rate or variable-rate mortgage) is a loan where the interest rate changes routinely, based on a benchmark rate such as the MCLR (Marginal Cost of Funds based Lending Rate) or the repo rate. This means that your monthly payments will also vary depending on the fluctuations in the market interest rates. An adjustable-rate mortgage offers flexibility and potential savings, as you can benefit from lower interest rates when they fall and adjust your budget when they rise.

Understanding the key differences between fixed-rate mortgages and adjustable-rate morgagages

Whether fixed or adjustable-rate, both types of home loan interest rates present pros and cons that may or may not be for you. Here is a deeper comparison of the pros and cons of fixed-rate vs adjustable-rate mortgages in India:

• Fixed-rate mortgages are more suitable for borrowers who prefer certainty and stability, who have a fixed income and expenses, and who do not plan to move or refinance in the near future. Fixed-rate mortgages also protect you from the risk of rising interest rates, which can increase your monthly payments and reduce your affordability.
• Fixed-rate mortgages are more expensive than adjustable-rate mortgages, as they usually have higher interest rates to compensate for the lender's risk of losing money if the market interest rates fall. Fixed-rate mortgages also have higher prepayment charges, which can discourage you from paying off your loan early or switching to another lender.
• Adjustable-rate mortgages are more suitable for borrowers who prefer flexibility and savings, who have a variable income and expenses, and who plan to move or refinance in the near future. Adjustable-rate mortgages also allow you to take advantage of lower interest rates when they fall, which can reduce your monthly payments and increase your affordability.
• Adjustable-rate mortgages are more risky than fixed-rate mortgages, as they expose you to the uncertainty of changing interest rates, which can increase your monthly payments and reduce your affordability. Adjustable-rate mortgages also have more complex terms and conditions, which can make it harder for you to understand and compare different loan options.

As you can see, there is no definitive answer to which type of mortgage is better for you. It depends on your personal preferences, financial goals, risk tolerance, and market expectations. Therefore, before you decide on a fixed-rate or an adjustable-rate mortgage, you should do your homework and compare different loan offers from various lenders. 

Here is a quick look at the dos and don’ts to help you out:

• Do: Compare the interest rates and fees of different lenders. You may find significant differences in the cost of borrowing among different banks and financial institutions. Shop around and negotiate for the best deal.
• Don't: Assume that the lowest interest rate is always the best option. A low rate may come with higher fees, penalties, or other hidden charges. Also, a low rate may not last for the entire loan term, especially if it is an ARM.
• Do: Consider your income stability and future plans. If you have a steady income and plan to stay in your home for a long time, an FRM may suit you. You will be certain to pay the same amount every month, regardless of market fluctuations.
• Don't: Opt for an ARM without understanding the risks. An ARM may offer a lower initial rate than an FRM, but it can change periodically based on an index. This means that your monthly payments can go up or down depending on the interest rate environment. You should be prepared to handle the potential increase in your payments and have a contingency plan in case of financial hardship.
• Do: Read the fine print and ask questions. Before signing any loan agreement, understand all the terms and conditions, such as the interest rate, fees, penalties, prepayment options, conversion options, etc. If anything is unclear or confusing, ask your lender for clarification.
• Don't: Sign anything that you don't understand or agree with. If you feel pressured or rushed by your lender, take your time and seek a second opinion. Remember that this is a major financial decision that will affect your life for years to come. You have the right to choose the loan that best suits your needs and goals.

Final Tip

Ultimately, don’t forget to consult a financial advisor or a mortgage broker who can help you find the best deal for your situation.