## What is a 'Fixed Interest Rate'

A fixed interest rate is an interest rate on a liability, such as a loan or mortgage, that remains the same either for the entire term of the loan or for part of the term. A fixed interest rate is attractive to borrowers who do not want their interest rates to rise over the term of their loans, increasing their interest expenses.

## BREAKING DOWN 'Fixed Interest Rate'

A fixed interest rate avoids the interest rate risk that comes with a floating or variable interest rate, in which the interest rate payable on a debt obligation varies depending on a benchmark interest rate or index.Homebuyers in particular should be aware of the pros and cons of loans with fixed rates. While shopping for a mortgage or another loan, consumers should compare fixed-rate loans to products with variable or floating interest rates.

## Advantages of Fixed Interest Rates

Because the interest rates on fixed-rate loans stay the same, the borrowers' payments also stay the same. This makes it easier to budget for the future. To illustrate, imagine someone buys a $375,000 home with 20% down, and he takes out a $300,000 mortgage with a 4% fixed interest rate with a 30-year term. Every month for the life of the loan, his payments are $1,432. The homeowner may face varying monthly bills as his property taxes change or his homeowners insurance premiums adjust, but his mortgage payment remains the same.

## Disadvantage of Fixed Interest Rates

Loans with adjustable or variable rates usually offer lower introductory rates than fixed-rate loans, making these loans more appealing than fixed-rate loans, especially when interest rates are high. As a result, borrowers are more likely to opt for fixed interest rates during periods of low interest rates; the opportunity cost, if interest rates go lower, is still much less than during periods of high interest rates.

## Difference Between Fixed and Variable Interest Rates

While fixed interest rates stay fixed or set, variable interest rates vary or adjust. For example, if a borrower takes out an adjustable rate mortgage (ARM), he typically receives an introductory rate for a set period of time, often for one, three or five years. After that point, the rate adjusts on a periodic basis, as outlined in the mortgage agreement.

To illustrate, imagine the bank gives the borrower a 3.5% introductory rate on a $300,000 30-year mortgage with a 5/1 ARM. During the first five years of the loan his monthly payments are $1,347. However, when the rate adjusts, it increases or decreases based on the interest rate set by the Federal Reserve or another benchmark index. If the rate adjusts to 6%, for example, the borrower's payments increase to $1,799. In contrast, if the rate falls to 3%, the monthly payments fall to $1,265. Conversely, if the 3.5% rate is fixed, the borrower faces the exact same $1,347 payment every month for 30 years.