The Pros and Cons of Adjustable-Rate Mortgages for Your Home Loan

Apart from fixed rate and floating rate home loans, potential borrowers looking for innovative housing finance solutions can also choose adjustable-rate home loans. This hybrid lending option offers the benefits of both types of interest rates. Adjustable-rate mortgages (ARM) are those home loans for which lenders set an initial period of fixed interest rate and then it changes to a higher or a lower interest rate. The floating component of the interest rate is typically tied to the Marginal Cost of Funds Based Lending Rate (MCLR), a benchmark rate set by the Reserve Bank of India.

It is important to understand the pros and cons of adjustable-rate mortgages for a home loan before choosing this unique housing finance option. 

Advantages of Adjustable-Rate Home Loans

• Initial Lower Interest Rates: 

One of the key benefits of adjustable-rate home loans is the initial component of fixed interest rates, which is lower than fixed-rate counterparts. This can be especially beneficial for homebuyers as it provides an affordable entry point into homeownership. 

• Potential for Interest Rate Decrease: 

If your interest rate drops, you naturally end up saving more money which allows you to use the market condition to your advantage. This can lead to substantial savings over the tenure of the loan.

• Short-Term Savings: 

In the short term, adjustable-rate home loans can result in lower monthly payments, which can free up your cash for investments, savings, insurance payments, and other liabilities.

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Disadvantages of Adjustable-rate Home Loans

• Interest Rate Volatility: 

The primary drawback of adjustable-rate home loans is their susceptibility to interest rate hikes. If market rates rise, so will your loan’s interest rate, potentially leading to higher monthly EMIs. This volatility can pose a financial challenge, especially for those who have a fixed income. 

• Uncertain Future Payments: 

Unlike fixed-rate home loans that provide stable monthly payments, adjustable-rate home loans introduce uncertainty in your budget. The unpredictability of whether interest rates will rise or fall makes it difficult for borrowers to plan their long-term budget. 

• Risk of Payment Shock: 

A significant risk associated with adjustable-rate home loans is the potential for payment shock. Due to uncertain market volatilities, interest rates may rise sharply. Hence, borrowers could face a sudden substantial increase in their monthly payments during the floating rate period. 

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Structure of Adjustable-rate Home Loans

The structure of adjustable-rate home loans typically includes – 

• Initial Fixed Period: 

Usually, the loan starts with a period of fixed interest rates, which could last up to a few years. During this time, interest rates remain constant, allowing borrowers the benefit of predictable EMI payments. 

• Adjustment Period: 

After this, your home loan’s interest rate will start adjusting at regular intervals, such as annually or biannually. This rate is determined by adding a margin (a fixed percentage) to the current index rate. 

• Interest Rate Cap: 

To protect borrowers from extreme hikes in interest rates, lenders often impose interest rate caps. These limit how much the interest rate can change during a specific period (e.g., annually or over the loan tenure). 

Factors to Consider Before Choosing Adjustable-rate Home Loans 

Current Market Conditions: 

Given the dynamic nature of India's real estate market, it is crucial to analyse current interest rate trends. Understanding the prevailing market conditions allows potential homebuyers to gauge whether an adjustable-rate home loan will be beneficial in the prevalent economic landscape. 

Personal Financial Situation: 

Individuals must assess their financial stability and risk tolerance before making a decision. You should be able to navigate potential interest rate fluctuations and ensure that the chosen mortgage aligns seamlessly with your financial health. 

Future Ownership Plans: 

Evaluate how long you intend to stay in the property. Adjustable-rate home loans are often more suitable for those who plan to own the property for a shorter duration. If you are making a long-term commitment, the stability of a fixed-rate home loan could be more suited for you. 

Budget Flexibility: 

Adjustable-rate home loans are more suited for borrowers with flexible budgets and the ability to absorb sudden changes in monthly payments. If you can tackle an increase in EMIs due to interest rate hikes, this type of home loan can be a beneficial choice. 

As a potential borrower, you must understand the pros and cons of adjustable-rate mortgage for a home loan to make an informed decision. Also remember to consider your financial situation and risk tolerance before deciding on the perfect funding option for your dream house. Wondering how to make a choice? Browse multiple Home Loan options from several top lenders on Bajaj Markets! Access a high loan amount of up to ₹15 Crores at interest rates starting from just 8.50% p.a.