Loans are a serious financial commitment and none requires as much research and thought as a home loan. After all, owning a home is a commendable achievement but with tenures running into decades, home loans require careful financial planning. Finance amounts acquired through home loans are considerably large sums of money and given the lengthy tenures, the biggest consideration of the borrowers are the interest rates.
Interest rates of Home Loan Home loans can be broadly clubbed into 2 groups. They are fixed interest rates and variable interest rates. The intricacies involved in each group can be exhaustive and many borrowers allow the bank to choose the policy for them but with a commitment this size it behoves the borrower to understand the basic premise of each type of interest rate. The article below explains Fixed rate interest and Variable rate interest charged on home loans.
Fixed Home Loan Rates
Fixed rate home loans, as the name suggests offer a fixed rate of interest for the entire duration of the loan tenure. There are no fluctuations in the rate of interest in such loans. For example if a borrower takes out a home loan with a fixed interest rate of 5% p.a. he/she will have to pay this rate of interest for the duration of the loan tenure Most fixed interest rate home loans are not flexible. The instalments to be paid every month cannot be altered and one cannot make additional payments on the instalments to speed up the repayment of the loans. At times, this can prove to be disadvantageous since any additional influx of cash cannot be utilized to repay the loan.
Typically, for fixed interest rate home loans, the interest rate is usually higher than variable interest rate home loans. This is done to offset any possible rise in a bank’s BLR(Base Lending Rate). Even though fixed interest rate home loans are commonly available in commercial banks, most of them tend to offer variable interest rate home loans and not market or promote the fixed interest rate home loans as aggressively.
Fixed rate home loans offer consistency in payments. One knows what their monthly instalments are and can pay them effectively through good financial management. Fixed rate home loans work best when there is a fixed source of income and any rise in interest on the monthly payments can throw a wrench in the budget for that month.
Most fixed interest rate home loans require the borrower to take up Mortgage Reducing Term Assurance (“MRTA”) and fire insurance with strict regulations and higher assured terms. While MRTA may be more expensive for fixed rate home loans, it is a viable option if there is only one breadwinner for the family in which case upon the borrower's death or permanent disability the MRTA would cover the balance of the loan amount.
Variable Home Loan Rates
Variable interest rate home loans as the name suggests are interest rates that can increase or fluctuate under certain circumstances and are pegged to the Bank’s base lending rate (BLR) as recommended by Bank Negara. Variable rates on home loans can increase or decrease based on fluctuations on the Bank’s base lending rate. Consider the following example. A borrower takes out a home loan with a variable interest rate of -2.5% on the current BLR of the bank. If the BLR of the bank is 6.5% then the effective interest applied on the home loan is 6.5% - 2.5% which is 4% p.a. This interest rate can go up if the BLR of the bank increases. If BLR becomes 7% the effective interest being paid will become 7% - 2.5% which is 4.5% p.a. Similarly if BLR reduces to 6% then interest rate will come down to 3.5% p.a.
Today, most borrowers prefer variable interest rates. This is primarily because the interest rates offered by fixed rate home loans are quite high and a borrower would end up paying more interest throughout the duration of the loan. For instance certain banks have an interest rate of 4.85% as fixed rate. On the other hand most commercial banks have the variable interest rate pegged to their BLR which usually amounts to 4.2% p.a. while a variable rate home loan offered by some Malaysian banks are going at 4.2% p.a. This difference of 0.65% may seem miniscule but taking the sizeable finance amount that home loans offer and the longer tenures, this 0.65% will add up to a considerable amount over the duration of the loan. For example if the loan amount has a principle of RM 500,000 the interest paid through fixed rate interest is RM 24,250 and through the variable rate interest is RM 21,000. This is a difference of RM 3250 in the first year alone.
This however is a double edged sword. BLR rates can rise as well and if the bank sees a drastic increase in its BLR, this change would reflect in the variable interest rate. If BLR goes up to say 8% and the variable interest is set to -2.4% the interest paid by the borrower will go up to a drastic 5.6% in which case the amount for interest payments alone will be RM 28,000 which is RM 3750 more than the fixed interest.
Variable rate home loans offer convenience by allowing for additional payments and option of withdrawing these additional payments which is not offered by fixed rate home loans.
Variable rate home loans also require MRTA and Fire insurance but the coverage periods and insured amounts are minimal and more cost effective.
Since one cannot predict the movement in BLR to a pinpoint accuracy, one cannot decide which Interest rate is financially better.Each type of interest rate has its own set of pros and cons that one should be aware of and should take up a loan only after due consideration and factoring in what works best for them in the long run.
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