A fixed-rate mortgage, which is one of the most basic and popular types of mortgages, has an interest rate that is set when the loan is originated and does not change over time. “Fixed rate” only defines the type of loan and not the terms. For example, most fixed-rate mortgages have a duration of 15 or 30 years, but some lenders offer terms of 10, 20 or even 40 years. Occasionally, lenders offer fixed-rate mortgages with a term of five or seven years with a balloon payment for the balance due at the end. As you shop for your new home, learn more about fixed-rate and other types of mortgages so you are sure to make the right choice for your financial situation.
What are the Benefits of a Fixed-Rate Mortgage?
When you take out a fixed-rate mortgage, your monthly payment of principal and interest will never change throughout the life of the loan. This gives you the security of knowing how much money you will have to pay for your loan each month, and you’ll never be impacted when interest rates rise. Since you know what your interest rate will be, it’s easy to perform some simple amortization calculations so that you’ll know how much equity you have built up in your home at any given time. Fixed-rate mortgages are also easy to understand, and there aren’t a lot of complicated terms and calculations.
Are There Any Disadvantages to a Fixed-Rate Mortgage?
While a fixed-rate mortgage protects you from any increase in interest rates, it also doesn’t let you take advantage of interests rates that go down. If the federal interest rate decreases to the point where it would save you a significant amount of money on your mortgage, you would have to refinance your loan to take advantage of the lower rate.
Since your lender has locked into the going interest rate when they originate the loan, they cannot take advantage of rising interest rates. Many lenders require a bit more in terms of credit scores and down payments for fixed-rate mortgages than they are with adjustable-rate mortgages (ARM) where the mortgage rate rises and falls with the federal rate.
How Does a Fixed-Rate Mortgage Compare to an Adjustable-Rate Mortgage?
Besides the difference in stable payments versus payments that may change over time, fixed-rates mortgages and ARMs have some other subtle differences. The initial interest rate on an ARM is typically lower than that of a fixed-rate mortgage, and that payment and rate are fixed for a certain period of time, although the length of the fixed-rate period changes drastically from lender to lender. Some may keep the rate fixed for as little as one month, and other lenders may keep it fixed for up to 10 years.
What Mortgage Terms are the Most Favorable?
Many home buyers opt for 30-year fixed rate mortgages as the monthly payments are lower than most other fixed-rate options. However, 30-year mortgages also tend to have higher interest rates than 15-year or 20-year mortgages. If you take out a $200,000 fixed-rate mortgage for 30 years with an interest rate of 4 percent, your monthly payments will be $954.83 and you will pay a total of $143,739 in interest throughout the life of the loan.
A 15-year fixed-rate mortgage with a lower interest rate of 3.5 percent will have higher payments of $1,429.77, but total interest paid by the end of the loan term is only $57,358, which is a significant difference. For a 20-year fixed-rate mortgage with a 3.75 percent rate, payments would be $1,185.78 per month, and you would pay a total of $84,586 by the end of the loan term.
Can I Pay Down My Mortgage Early?
Most lenders don’t assess penalties if you pay off your fixed-rate mortgage early, but it’s best to check the fine print before you finalize the deal. If you do plan to pay off your mortgage sooner than the agreed-upon term, you have several options:
- Pay a small additional amount toward the principal each month or a larger amount once per year
- Double the principal amount each month
- Make an extra mortgage payment each year
Most people find it easy to pay an additional amount each month, although some use their tax refund checks to make one additional payment each year. The same holds true for people who draw regular paychecks throughout the year and then get an annual bonus or commission at the end of the year.
Using the 30-year $200,000 mortgage at 4 percent with the $954.83 payment each month, consider this scenario. If you pay an additional $100 per month toward the principal, your payments would still be significantly less than the $1,429.77 for a similar 15-year mortgage, but you would save almost $27,000 in interest and reduce the length of the loan by five years. If you make one extra mortgage payment each year, you would save more than $21,000 in interest payments and reduce the length of the loan by roughly four years.
How Do I Know Which Type of Mortgage Is Right for Me?
Everyone’s financial situation is different, so there’s no one-size-fits-all when it comes to mortgages. If you plan to stay in your new home for many years, a fixed-rate mortgage is probably your best bet as your payments will remain stable. If you plan to refinance at some point, opt for a 15-year fixed-rate mortgage. If you plan to stay in your new home for five to seven years or less, you might be a good candidate for an adjustable-rate mortgage.
2 Point Highlight
When you take out a fixed-rate mortgage, your monthly payment of principal and interest will never change throughout the life of the loan.
Fixed-rate mortgages are also easy to understand, and there aren’t a lot of complicated terms and calculations.
