Fixed Rate Mortgages
A fixed-rate mortgage is the most ordinary and uncomplicated mortgage available to homeowners today. It is also far and away the most popular choice for borrowers.
As the name suggests, the interest rate on a fixed mortgage does not change at all during the entire duration of the loan, which is typically 30 years.
Fixed Mortgages Are Easy to Understand and Surprise-Free
For that reason, fixed-rate mortgages do not have associated mortgage indexes, margins, or caps because they are not variable-rate loans. It s basically a set-it-and-forget-it loan program that s easy to understand.
Another key characteristic of the fixed-rate mortgage is that monthly principal and interest mortgage payments remain constant throughout the life of the loan, to the very last month when the loan is finally paid off.
In other words, there aren t too many surprises with a fixed-rate loan, making it easier for the homeowner to sleep at night. Of course, that certainty does come at a cost, namely, a higher mortgage rate relative to adjustable-rate options.
However, a 30-year fixed might not cost much more than a 5/1 ARM, depending on the rate environment at the time you re shopping for a loan.
For example, a 30-year fixed today might be offered at around 3.75%, while a 5/1 ARM might be available for 3%.
This 0.75% spread is the cost of securing that fixed rate. Or the discount of going with the ARM instead.
On a $200,000 loan amount, we re talking a difference of about $125 per month in mortgage payment. For some folks, that s a small price to pay for a surprise-free mortgage. For others, it means leaving money on the table and paying more than necessary.
That higher rate also means your mortgage balance is paid off slightly slower than the low-rate option, which could be important if you re trying to build equity and eventually refinance.
It s very important to determine what type of loan is right for you early on in the loan process, instead of having your loan officer influence that decision.
While the 30-year fixed is definitely the most popular choice among homeowners, it s not necessarily the right fit for all borrowers. So do your research beforehand!
Types of Fixed-Rate Mortgages
The most common type of fixed-rate mortgage is the 30-year fixed, which amortizes over thirty years, with the majority of early payments going toward interest, and the bulk of later payments going toward principal.
The next most popular term for a fixed mortgage is the 15-year fixed loan, which amortizes over fifteen years, bumping up monthly mortgage payments significantly, but reducing the amount of interest paid throughout the duration of the loan considerably.
Many banks and mortgage lenders also offer 10, 20, 25, 40, and 50-year fixed loans as well, though they are far less popular and widespread.
You may also be able to choose your own term, via programs like Quicken s Yourgage, and through similar programs offered by other lenders.
If you want a certain term, just let them know and they might be able to accommodate you. A shorter fixed term means a higher payment, but it also equates to a lot less interest and a home that is free and clear that much faster.
Fixed Mortgages with Interest-Only Options
Some fixed-rate mortgages also feature interest-only periods, which allow homeowners to make interest-only payments during the first five to ten years of the loan term, though the loan will recast once the interest-only period is up to account for any reduced payments made during that period.
In other words, payments after the interest-only period expires will be higher to compensate for lower payments made early on. However, the mortgage is still considered fixed. It is simply recalculated to reflect the remaining number of months and the remaining mortgage balance.
Fixed-Rate Mortgage Benefits
Fixed-rate mortgages are beneficial for a number of reasons, though the fact that your mortgage payment will never change is clearly paramount.
If interest rates rise, homeowners with adjustable-rate mortgages will suffer the consequences of higher monthly mortgage payments, while fixed-rate borrowers can rest assured that their payments will not change under any circumstances.
Fixed mortgage borrowers won’t need to worry too much about where the market is headed either, though it’s wise to monitor interest rates in case a sizable interest rate drop makes it favorable to refinance.
But generally, it’s a pretty stress-free loan choice, and one that’s favored by many government programs (FHA loans, VA loans) for its stability and clear-cut nature.
Put simply, the fixed mortgage is a good choice for the borrower that actually wants to pay off their mortgage, and plans to stay in the home (and with the mortgage) for the foreseeable future.
One Downside of a Fixed Mortgage
The only real negative aspect of a fixed-rate mortgage is the higher interest rate, although these days many fixed mortgages price fairly closely to adjustable-rate mortgages.
Typically, homeowners pay a premium to lock in a fixed mortgage rate, whereas adjustable-rate mortgages may be discounted, especially early on.
So a 30-year fixed mortgage rate may be one percentage point higher than say a 5/1 ARM, but the borrower who goes with the fixed loan is banking on payment stability in exchange for a higher upfront cost. The borrower with the ARM is essentially taking a risk that rates won t rise in the future.
Another small negative associated with a fixed-rate mortgage is the idea that many homeowners will fail to refinance when a good opportunity comes around because they re so obsessed with holding onto their low fixed rate.
Basically a homeowner with a fixed mortgage may avoid refinancing in fear of losing that fixed-rate, whereas an ARM-borrower is always keen to shop around in order to save money.
A homeowner can also lose the advantage of a fixed mortgage if they sell or refinance within a few short years. In that case, they could have just taken out an ARM that was fixed for the first five or seven years and enjoyed a stable rate at a lower price.
But all in all, fixed mortgages are a good choice for a wide range of borrowers because of the relative low risk and lack of surprise. And with fixed mortgage rates at historic lows, there couldn t be a better time to obtain one for the long term.
Check out the chart below, which illustrates the interest rate movement of the popular 30-year fixed-rate mortgage over the course of 2010: