What Is a Fixed Rate Mortgage?

What Is a Fixed Rate Mortgage?
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Mortgages aren’t one-size-fits-all. There are many types of mortgages. There is variety in the term of the loan, down payment amount, amortization schedule and more depending on your credit score and the loan type you select for your home loan. All of this impacts your total interest cost, closing costs and monthly payments. You can select the one that best suits your personal finances and goals. A fixed mortgage rate might be most suitable for those who don’t like surprises. It’s consistent, something you can count on year after year and factor seamlessly into your budget. But it’s not perfect. It's more appropriate for some borrowers than for others.

What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage is exactly what it sounds like: your mortgage interest rate is fixed and carved in stone for the entire life of the loan. Your mortgage payment will always stay exactly the same, unless it includes homeowners insurance, property taxes or both. Some lenders escrow for taxes and insurance, wrapping that money into your monthly payment, then they pay these bills on your behalf when they come due.

Your monthly mortgage payments can still shift a little if there’s an increase or decrease in your property taxes and home insurance, even with a fixed-rate loan, but your monthly principal and interest payments will always remain the same. The prevailing interest rate can plummet or soar over the years, but that won’t affect you, at least where your mortgage is concerned. Your rate will remain unchanged regardless.

Fixed-rate mortgages are more or less the standard, and they’re available as conventional loans, FHA loans and VA mortgage loans.

One of the most important factors in deciding whether a fixed-rate mortgage loan is right for you is the length of time you’re planning to stay in your purchased home.

Fixed-Rate Mortgage Loan Terms

You can decide how long your mortgage loan will last when you apply for one. The "term" of a mortgage is the number of years over which you’ll be paying the loan amount. Common terms are 15 or 30 years.

The principal portion of your mortgage payment will obviously be less if you choose 30 years because you're stretching the loan amount out over more payments. You’d be paying about $555 a month in principal each month if you borrowed $200,000: Your $200,000 debt divided by 360, or 12 months times 30 years. This jumps to $1,111 or so if you cut that 30-year mortgage term in half to 15 years – but you’ll also be done with your mortgage in half the time and you’ll build your home equity in the property more quickly.

Then there’s the interest. You’ll be paying that fixed interest rate for an additional 180 months if you take out a 30-year fixed-rate mortgage rather than a 15-year mortgage, but the interest rate is typically less on a 15-year loan term. Lenders reward borrowers with a lower interest rate when they're willing to pay off their mortgages sooner rather than later.

Fixed-Rate vs. Adjustable-Rate Loans

Deciding on your loan term isn’t the only choice you’ll have to make when you’re applying for a mortgage. There’s another popular option out there: adjustable-rate loans. These are effectively the opposite of fixed-rate mortgages. You’ll have one consistent interest rate with this type of loan as well, but only for a short period of time before it adjusts. Your rate can climb after this period or potentially decrease, more or less keeping pace with the economy and the prevailing interest rate. Your rate can change as often as every six months, and it often increases.

The initial fixed-rate period can be as short as one year, or as long as 10 years, according to the Federal Deposit Insurance Corporation, or FDIC. But your interest rate during this initial period will most likely be less – maybe even significantly less – than it would be with a fixed-rate loan. You’re looking at a stretch of time during which you can enjoy comparatively small monthly payments.

You might cringe at your monthly payments after this point, however, if prevailing interest rates have skyrocketed in the interim. Some homebuyers figure they’ll refinance before this term expires, but that’s not always a viable option. You’d most likely be paying that higher prevailing interest rate either way, on your variable rate loan or a new mortgage that’s beginning at a time when rates are high.

The Consumer Financial Protection Bureau indicates that only 25 percent to 30 percent of homebuyers choose adjustable-rate mortgages. That leaves 70 percent to 75 percent who are opting for fixed-rate loans.

Pros and Cons of Fixed-Rate Mortgages

Can 70 percent to 75 percent of homebuyers be wrong? Well, yes. There a couple of drawbacks to a fixed-rate mortgage.

That locked interest rate is going to be higher than it would be with an adjustable-rate loan, at least in the short term. And you’re locked in, even if the prevailing interest rate plunges several years into your mortgage loan. New borrowers will get that current interest rate, while you're stuck with the one you agreed to when you first took out your mortgage. The only way out is to refinance.

And again, your interest rate isn’t the only thing that affects your monthly payments. You might believe you only have to pay X number of dollars every month for 15 or 30 years, but your mortgage payments will nonetheless increase if property taxes in your area soar and if you’re paying those taxes through an escrow account with your mortgage lender. Property tax increases aren’t unheard of over a period of decades, and your insurance rates can go up as well, particularly if you make multiple claims.

That said, your mortgage payments most likely won’t change as frequently or as much as they would with an adjustable-rate mortgage. That interest rate is what it is, and you can count on that. This can be a good thing if you’re one of those who lives or dies by your budget, and you want to have a very good idea of what your home is going to cost you over the long haul.

Is a Fixed-Rate Loan Right for You?

One of the most important factors in deciding whether a fixed-rate mortgage loan is right for you is the length of time you’re planning to stay in your purchased home. Is it your intention to grow old there? Do you picture your grandchildren gathered at a table in the dining room? You might prefer long-term consistency in your monthly payments in this case. The prevailing interest rate can explode over that extended period of time, but your mortgage payment will remain more or less consistent.

You might opt for a lower-interest, adjustable-rate loan instead and enjoy a few years of rock-bottom payments if you are a first-time homebuyer, this is your starter home and you plan to move on at some point, maybe in five to 10 years.

And 30 years – if even 15 or 20 years – might not be a feasible loan term if you're approaching retirement. You’re effectively throwing a monkey wrench into your estate plan for your heirs to deal with unless you’re pretty confident that you’ll live to be a ripe old age. And that consistent mortgage payment with its slightly higher interest rate might turn out to be too much for your retirement budget.