Home loans: Fixed vs floating rates - which one to choose?

Getting a home loan is very easy nowadays. However, choosing the best option is always a complex aspect. One should do proper homework before rushing in to something. While applying for a home loan, the first thing that will bother the applicants is whether to go for fixed interest rate or floating interest rate. Let us see which option is better.

Fixed interest rate
Fixed interest rate means repayment of home loans in fixed equal installments over the entire period of the loan. In this case, the interest rate doesn't change with market fluctuations. During the early part of the loan tenure the majority of monthly payments are used to service the interest and the principal is served in the later parts of the tenure.

Benefits

• Interest rate remains fixed irrespective of market conditions
• A fixed-rate home loan is excellent for those who are good at budgeting and want a fixed monthly repayment schedule, which is easy to budget and doesn't fluctuate
• It brings a sense of certainty and security

Drawbacks

• The major drawback with fixed interest rates is that they are usually 1-2.5 percentage points higher than the floating rate home loan. Secondly, if for any reason the interest rate decreases, the fixed rate home loan doesn't get the benefit of reduced rates and the borrower has to repay the same amount every time. Another area of concern is whether the fixed rate home loan is fixed for the entire tenure or only for a few years. This has to be cross-checked with the bank while taking the home loan. A fixed home loan, which can be changed every few years, will definitely wipe out the very spirit of such a loan. Experts agree on the fact fixed rates are a better option if the economic scenario promises a rise in interest rates in the near future.
  

Floating interest rate
Floating interest rate by name implies that the rate of interest varies with market conditions. Home loans on floating interest rates are tied to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies.

Benefits

• The biggest benefit with floating rate home loans is that they are cheaper than fixed interest rates. So, if you are getting a floating interest rate of 11.5 per cent while the fixed loan is being offered at 14 per cent, you still save money if the floating interest rate rises by up to 2.5 percentage points.
• Even if the floating rate goes over the fixed rate, it will be for some period of the loan and not the entire tenure. The interest rates will surely fall over a long period and, thus, the floating interest rate brings a lot of savings.

Drawbacks
The drawback with floating interest rates is the uneven nature of monthly installments. This makes it difficult to budget with floating interest rate home loans. As seen in recent times, due to the hike in floating home loan interest rates, the borrowers had to shell out thousands per month extra as their EMIs, throwing their entire budget out of order.

Let us understand it with an example. Suppose you have taken a loan of Rs. 25 Lakh for 20 years.

• Floating interest rate is 9.75 per cent
• Fixed interest rate is 10.5 per cent

If you go with the floating interest rate then the EMI will come to around Rs. 23,712, whereas the EMI under fixed interest rate option will be Rs. 26,660. So, if you choose floating rate, you end up saving around Rs. 2,948 every month. Though this amount looks small, it will make a big difference in the long term.

However, you will benefit by choosing a floating rate home loan only as long as the interest rate does not go beyond 11.5 per cent.

Conclusion
When it comes to choosing the interest rate, a majority of home loan borrowers go for floating rates.

Finally, it is up to the borrower to decide what suits him best. Before taking a decision, it is advisable for the borrower to compare home loans from different institutions in detail, including the various parameters set forth. If certainty and security are prime considerations, a fixed rate home loan will be the best. However, it won't come without the premium on interest rates.

Home loan and HRA: how the tax works out

Ajit, currently employed with Company A, is staying in a rented apartment in Mumbai and has bought himself a property in Chennai for which he has taken a home loan. He finds himself in a dilemma while filing tax returns. "Can I claim both HRA and home loan benefits?" This seems to be a confusing factor for most tax payers. When Ajit pays rent, under the Income tax act, he is definitely allowed to claim both HRA and home loan benefits (interest payment and principal repayment).

Also Read: Five things to know about HRA

Let us evaluate various possible situations an individual can find himself in and understand what the Income Tax Act permits him to do.

1: You live in your own house
You have taken a home loan and residing in the house purchased with it. Since you are residing in your own house, you will not be able to claim HRA. However, you will be able to claim tax benefits on both the principal and interest repaid on the home loan.

2: You own a house in another city
This situation was the one faced by Ajit. He resided in Mumbai but had bought an apartment in Chennai taking a home loan. Ajit will be entitled to HRA exemption and tax benefits on both, the principal and interest repaid on the home loan.

3: Your house cannot be occupied at this point (e.g. under construction)
You have bought a house in Mumbai taking a home loan and you're currently living in Mumbai in a rented apartment because the house is under construction. In such a case, you are eligible to claim HRA.
In the case of tax breaks on the home loan, you can claim tax benefits only for your principal before the completion of your house. Once your house is completed, you can claim tax benefits on the total interest paid up to the date of completion in five equal installments in five years beginning from the year of completion.

4: You have a house which is ready for occupation but you cannot reside in it
You have bought a house in Delhi taking a home loan and now you aren't residing in it but are living in a rented apartment in Delhi itself for genuine reasons e.g. the house that you have bought is far away from your office. In such cases, the Income tax act permits the individual to claim HRA and home loan benefits which includes both principal and interest repaid on the home loan.

Also, please note that if your house remains vacant, then you will still need to pay tax on a notional rent income.

5: You have rented your own house and currently residing in a rented house
You took a home loan and your house is now ready for occupation. You have rented the same out while you reside in a rented house. The Income Tax Act allows you to claim both HRA and home loan benefits.

However, in such a case, since you are the recipient of rent because you have let out your own house, that income is taxable at your hands.

The Income Tax Act treats HRA and home loan deductions under separate sections independently. The two are not interconnected to each other. HRA is dealt with in section 10(13A) Rule 2A while home loans are entitled for tax benefits under section 80C (tax benefit on principal repayment) and Section 24 (tax benefit on interest payment) of the Income Tax Act. Hence, feel free to avail both tax benefits accordingly.

Now that we have dealt with all possible situations with regard to availing HRA and home loan tax benefits, let's take Ajit's situation as an example to help you figure out how to avail them.

Claiming tax benefits on a home loan:
Ajit had purchased an apartment in Chennai for Rs. 38 lakh three years back. He took a home loan of Rs. 32 lakh to fund this house purchase. So far, this year he has repaid an interest of Rs. 3.3 lakh and a principal amount of Rs. 60,000.

Section 80C offers tax rebate on home loan principal up to a limit of Rs. 1 lakh and Section 24 on interest up to a limit of Rs. 1.5 lakh. So Ajit can utilize up to Rs.1.5L on his interest paid and avail the tax benefits in full for the amount paid towards principal.

Calculating tax benefits on HRA:
Ajit earns a basic salary of Rs. 40,000 per month and has rented an apartment in Mumbai for Rs. 20,000 per month (he is eligible for 50 per cent of the basic pay for HRA exemption, as he resides in a metro). The actual HRA he receives is Rs. 25,000. These values are considered to find out his HRA tax exemption:

a. Actual HRA allowance from the employer, i.e. Rs. 25,000,
b. fifty per cent of the basic salary as he resides in a metro (else 40per cent), i.e. Rs. 20,000, and,
c. The actual rent he pays for the house from which 10 per cent of his basic pay is deducted, i.e. Rs. 20,000 - Rs. 4,000 = Rs. 16,000

The value considered for his actual HRA exemption will be the least value of the above figures. Hence, the taxable HRA amount for Ajit per month will be Rs. 25,000- 16,000 (available HRA deduction) = Rs. 9,000.