What Is a Fixed-Rate Mortgage?
A fixed-rate mortgage is a mortgage loan that has a fixed interest rate for the entire term of the loan. Generally, lenders can offer either fixed, variable or adjustable rate mortgage loans with fixed-rate monthly installment loans being one of the most popular mortgage product offerings.
Fixed-Rate Mortgage Explained
Fixed-rate mortgages are generally offered as amortized loans with installment payments, however non-amortizing loans can also be issued with a fixed-rate. There are varying risks involved for both borrowers and lenders in fixed-rate mortgage loans. These risks are usually centered around the interest rate environment. In a time of rising rates, a fixed-rate mortgage will have a lower risk for a borrower and higher risk for a lender. If rates are rising, borrowers typically seek to lock in lower rates of interest to save on interest rate costs over time. When rates are rising, interest rate risk is higher for lenders since they have foregone profits from issuing fixed-rate mortgage loans that could be earning higher interest over time in a variable rate scenario.
Amortized Fixed-Rate Mortgage Loans
Amortized fixed-rate mortgage loans are one of the most common types of mortgage loan offerings from lenders. This loan has a fixed-rate of interest over the life of the loan and steady installment payments. A fixed-rate amortizing mortgage loan requires a basis amortization schedule to be generated by the lender.
An amortization schedule is easiest to calculate with fixed-rate interest since it can be fully created at the issuance of the loan. Overall, the distinguishing factor of a fixed-rate mortgage is that the interest rate for every installment payment does not change and is known at the time the mortgage is issued. This allows a lender to create a payment schedule with constant payments over the entire life of the loan. This differs from a variable rate mortgage where a borrower has to contend with varying loan payment amounts that fluctuate with interest rate movements.
In a fixed-rate amortizing loan a borrower pays both principal and interest in each payment. Generally, as the loan matures the amortization schedule requires the borrower to pay more principal and less interest with each payment.
Adjustable Rate Mortgages
Adjustable rate mortgages are a fixed and variable rate hybrid. These loans are also usually issued as an amortized loan with steady installment payments over the life of the loan. They require fixed-rate interest in the first few years of the loan followed by variable rate interest after that. Amortization schedules can be slightly more complex with these loans since rates for a portion of the loan are variable. Thus, investors can expect to have varying payment amounts rather than consistent payments as with a fixed-rate loan.
In an adjustable rate mortgage, a borrower typically bets on rates to be falling in the future. If rates are falling, a borrower’s interest will decrease over time.
Fixed-rate mortgages can also be issued as non-amortizing loans. These are usually referred to as balloon payment loans or interest-only loans. Lenders have some flexibility in how they can structure these alternative loans with fixed interest rates. A common structuring for balloon payment loans is to charge borrowers annual deferred interest. This requires interest to be calculated annually based on the borrower’s annual interest rate. Interest is then deferred and added to the lump sum balloon payment required by the lender.
In an interest-only fixed-rate loan, borrowers pay only interest in scheduled payments. These loans typically charge monthly interest based on a fixed-rate. Borrowers make monthly payments of interest with no payment of principal required until a specified date.