A fixed-rate mortgage is a type of home loan where the interest rate stays the same over the life of the loan. It can create stability, because your principal and interest mortgage payment remains the same over the life of the loan.
How Does a Fixed-Rate Mortgage Work?
A fixed-rate mortgage is exactly that, a home loan with an interest rate that stays the same. If you have a 15 year fixed-rate mortgage with a 4% interest rate, it won’t jump to 6% if the market changes. The property taxes and insurance costs might change, but the principal and interest payment will remain constant. The most popular terms for fixed-rate mortgages are 15 and 30 years. If you want to take advantage of a lower interest rate with a fixed-rate mortgage, you will need to refinance.
A fixed-rate mortgage is different from an adjustable rate mortgage (ARM), that has a fluctuating interest rate. An ARM usually starts with a low, introductory interest rate, which adjusts at set intervals depending on the current market rate. A popular ARM loan term is a 3/1. The interest rate is the introductory rate for the first 3 years, and then adjusts every year after that for the life of the loan.
Benefits of a Fixed-Rate Mortgage
A fixed-rate mortgage is the most popular type of home loan. In 2021, 30 year fixed-rate mortgages took up 70% of the market share. Fixed-rate mortgages as a whole were about 89% of the market, while all combined forms of ARMs were only 11% of the total market. There are many reasons fixed-rate mortgages are common.
- The stability of knowing your monthly payment won’t fluctuate. Unless you are expecting your income to increase, like for a recent college graduate or someone just starting in their career, the consistent payment is usually welcomed. Someone who plans to make significantly more money in the near future, might benefit from an ARM, where it is okay if the payment increases over time if interest rates rise.
- A fixed-rate loan is usually easy to understand, and doesn’t vary much from lender to lender. It is also easy to calculate the long-term cost of borrowing.
- There are fixed-rate loan programs for most types of buyers including first-time buyers, expensive homes, and vacation and investment properties.
Cons of a Fixed-Rate Mortgage
Many people applying for a mortgage choose a fixed-rate mortgage for the stability of the principal and interest payment on their home loan. However, in some circumstances, a fixed-rate mortgage might not be the best option.
- There is no introductory interest rate. In an ARM there is usually a lower rate initially, making the monthly payments lower for the initial period of the loan. The lower introductory rate can be beneficial if you aren’t planning on staying in the home long-term. But the stability of a fixed-rate mortgage is sometimes preferred if you won’t be selling the house within the next 10-15 years and you want your payments to be stable.
- There is no benefit if interest rates fall. In a fixed-rate mortgage, the only way to take advantage of lower interest rates is to refinance the loan. In an adjustable rate mortgage, the rate adjusts over-time, which works well when interest rates fall. However, there is the risk that rates will increase, meaning your monthly payment will also go up.
- You could end up spending more money over the life of the loan if the interest rates drop and you don’t refinance. With an ARM, your payment would fluctuate with the interest rates, whether high or low.
- When interest rates are high, it can be harder to qualify for a fixed-rate mortgage because of the large monthly payments.
A qualified mortgage specialist can help you evaluate your financial goals and go over the best home loan options for your situation.