Fixed-rate mortgages

What is a Fixed-Rate Mortgage?

The term “fixed-rate mortgage” refers to a home loan with a fixed interest rate for the life of the loan. This means that the mortgage has a constant interest rate from start to finish. Terms can range from 10 to 30 years for fixed-rate mortgages, which are popular products for consumers who want to know how much they will pay each month.

Key points

  • A fixed-rate mortgage is a home loan with a fixed interest rate for the life of the loan.
  • Once fixed, the interest rate does not change based on market conditions.
  • Borrowers who want predictability and those who tend to own property for a long time tend to prefer fixed-rate mortgages.
  • Most fixed-rate mortgages are amortized loans.
  • Unlike fixed-rate mortgages, there are adjustable-rate mortgages whose interest rates change over the life of the loan.

How Fixed-Rate Mortgages Work

There are several types of mortgage products available on the market. Lenders advertise and offer variable or adjustable-rate mortgages or fixed-rate loans. In the case of floating rate loans, the interest rate is not fixed. Instead, rates are adjusted above a certain benchmark. These rates tend to change over certain periods. Fixed rate mortgages, on the other hand, have the same interest rate over the life of the loan.

Most mortgages that buy a home for the long term end up fixing the interest rate with a fixed mortgage. They prefer these mortgage products because they are more predictable. In short, borrowers know how much they will pay each month, so there are no surprises.

Unlike variable and adjustable-rate mortgages, fixed-rate mortgages do not change with the market . Thus, the interest rate on a fixed-rate mortgage remains the same no matter where interest rates go, up or down.

The amount of interest that borrowers pay on fixed-rate mortgages varies depending on how long they amortize . Mortgagors pay more interest in the initial stages of repayment. Later, more money is applied to the principal . Thus, someone with a 15-year repayment term will pay less interest than someone with a 30-year fixed-rate mortgage.

Special Considerations

Most amortized loans have a fixed interest rate, although there are cases where loans without amortization also have a fixed interest rate.

Amortized loans.

Amortized fixed-rate mortgages are some of the most common types of mortgages offered by lenders. These loans have fixed interest rates over the life of the loan and stable installment payments. A fixed-rate mortgage loan requires the lender to make a basic repayment schedule .

You can easily calculate a repayment schedule with a fixed interest rate when you originate your loan. This is because the interest rate on a fixed-rate mortgage does not change for each installment payment. This allows the lender to create a repayment schedule with constant payments throughout the life of the loan.

As the loan matures, the repayment schedule requires the borrower to pay more principal and less interest with each payment. This is different from a variable-rate mortgage, where the borrower has to deal with different loan payment amounts that fluctuate with changes in interest rates.

Unamortized loans.

Fixed-rate mortgages can also be made as unsecured loans. They are commonly referred to as payday or interest rate loans . Lenders have some flexibility in how they can structure these alternative fixed-rate loans.

The usual structure for large payday loans is to charge borrowers annual deferred interest. This requires that interest be calculated annually based on the borrower’s annual interest rate. Interest is then deferred and added to the lump sum payment at the end of the loan term.

In the case of a fixed-rate loan, borrowers pay only scheduled interest. These loans usually charge monthly interest at a fixed rate. Borrowers make monthly interest payments without paying principal until a specified date.

Fixed-rate mortgages and adjustable-rate mortgages

Adjustable-rate mortgages are a hybrid of fixed-rate and variable-rate . These loans are also usually in the form of an amortized loan with constant installment payments over the life of the loan. They require a fixed interest rate for the first few years of the loan and then a variable interest rate.

The repayment schedules for these loans can be a little more complicated because the rates on a portion of the loan are variable. Thus, investors can expect varying amounts of payments rather than fixed payments, as is the case with a fixed-rate loan.

Adjustable-rate mortgages are usually preferred by people who do not mind the unpredictability of ups and downs refinancing or will not own the property for a long period of time, also prefer ARMs. Borrowers usually bet on lower rates in the future. If rates do fall, the borrower’s interest will decrease over time.

Advantages and disadvantages of fixed-rate mortgages

Fixed-rate mortgages come with various risks for both borrowers and lenders. These risks are usually related to the interest rate environment. When interest rates rise, a fixed-rate mortgage will have less risk for the borrower and more risk for the lender.

Borrowers usually seek to lock in lower interest rates to save money over time. When rates go up, the borrower maintains a lower payment compared to current market conditions. On the other hand, the lending bank does not earn as much as it could from prevailing higher interest rates; foregoing profits from fixed-rate mortgages, which can yield higher interest rates over time in a floating-rate scenario.

The opposite is true in a market with falling interest rates. Borrowers pay more on their mortgages than current market conditions allow. Lenders make a higher profit on their fixed-rate mortgages than they would if they issued fixed-rate mortgages under current conditions.

Of course, borrowers can refinance their fixed-rate mortgages at prevailing rates if they are lower, but they would have to pay substantial fees to do so.