Tuesday, 24 November 2015

More about interest rates

Applying for a loan to finance your dream home? The process includes going through the various aspects in detail, so that you can get yourself the best possible deal.
When you avail of a loan, the terms of repayment include having to pay interest on the loan amount, for the tenure of the loan. Before you go ahead and finalise your loan (and lender), keep in mind that the types of interest rates vary and that you should choose one that best suits your needs.
Fixed interest rate
The way this works is simple: the interest rate will not change during the tenure of the loan.
  • Why choose a fixed rate of interest:
A fixed rate does not get affected by the changes/ fluctuations in the interest rates, which means that when you choose this option, the amount you will have to repay each month stays constant for the term.
Depending upon the interest rate scenario, fixed rates can often be lower (and therefore turn out to be more economical) compared to floating rates.
  • Factors against a fixed rate of interest:
Consider a scenario wherein owing to market conditions, the floating rate prevailing at the time dips and goes lower than the fixed rate that you have opted for. In this case, you have no option but to continue with the fixed rate, albeit at a higher cost.
If you believe you can deal with the idea of (possible) uncertainty, then a fixed rate is not the option for you. Instead, you could consider the alternative – floating rate – and service your loan accordingly.
Floating interest rate
With this option, the interest rate will go up or down depending upon the interest rate changes in the market. While this is dependent on a number of factors, it does affect your loan repayment capacity.
  • Why choose a floating rate of interest
You can choose to switch to a fixed rate of interest whenever you believe the timing is right.
If the interest rates go down, it is wholly possible to repay your loan faster even if your repayment amount remains the same.
  • Factors against a fixed rate of interest:
It is possible that being a floating rate, it can go up higher than a fixed rate would.
In this scenario, your repayment amount will be proportionately higher, which could impact your finances for a period of time.
Reducing rate of interest
As the term suggests, reducing rate is calculated each month basis the outstanding loan amount. The repayment amount in this case includes the interest payable on the outstanding amount, in addition to the principal repayment. However, after each payment cycle, the outstanding loan amount reduces and hence consumers do choose this option, should the lender offer it.
  • Why choose a reducing rate of interest:
This is a prudent way of paying interest, as you are paying interest only on the outstanding loan amount. Compare this to a fixed rate wherein you continue to pay interest on the loan amount, irrespective of the amount you have already paid off.
  • Factors against a reducing rate of interest:
Calculating the reducing rate of interest can be quite a task! Often, people find it simpler to avail of the fixed interest rate option as a result.
In conclusion
When you are considering the options available to you, keep in mind the whole picture. Choose the rate of interest as per what you are able to pay comfortably, allowing for other expenses that are an intrinsic part of our lives.

The choices available to a consumer are plenty, so choose wisely and choose well!

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