What Is a Fixed-Rate Mortgage?

The term “fixed-rate mortgage” refers to a home loan that has a fixed interest rate for the entire term of the loan. This means that the mortgage carries a constant interest rate from beginning to end. Fixed-rate mortgages are popular products for consumers who want to know how much they’ll pay every month.

Key Takeaways

  • A fixed-rate mortgage is a home loan with a fixed interest rate for the entire term of the loan.
  • Once locked in, the interest rate does not fluctuate with market conditions.
  • Borrowers who want predictability and/or who tend to hold property for the long term tend to prefer fixed-rate mortgages.
  • Most fixed-rate mortgages are amortized loans.
  • In contrast to fixed-rate mortgages are adjustable-rate mortgages, whose interest rates change over the course of the loan.

How a Fixed-Rate Mortgage Works

Several kinds of mortgage products are available on the market, but they boil down to two basic categories: variable-rate loans and fixed-rate loans. With variable-rate loans, the interest rate is set above a certain benchmark and then fluctuates—changing at certain periods.

Fixed-rate mortgages, on the other hand, carry the same interest rate throughout the entire length of the loan. Unlike variable- and adjustable-rate mortgages, fixed-rate mortgages don’t fluctuate with the market. So the interest rate in a fixed-rate mortgage stays the same regardless of where interest rates go—up or down.

Adjustable-rate mortgages (ARMs) are something of a hybrid between fixed- and variable-rate loans. An initial interest rate is fixed for a period of time, usually several years. After that, the interest rate resets periodically, at annual or even monthly intervals.

Most mortgagors who purchase a home for the long term end up locking in an interest rate with a fixed-rate mortgage. They prefer these mortgage products because they’re more predictable. In short, borrowers know how much they’ll be expected to pay each month, so there are no surprises.

Fixed-Rate Mortgage Terms

The mortgage term is basically the life span of the loan—that is, how long you have to make payments on it.

In the United States, terms can range anywhere from 10 to 30 years for fixed-rate mortgages; 10, 15, 20, and 30 years are the usual increments. Of all the term options, the most popular is 30 years, followed by 15 years.

The 30-year fixed-rate mortgage is the product of choice for nearly 90% of today’s homeowners.

How to Calculate Fixed-Rate Mortgage Costs

The actual amount of interest that borrowers pay with fixed-rate mortgages varies based on how long the loan is amortized (that is, how long the payments are spread out for). While the interest rate on the mortgage and the amounts of the monthly payments themselves don’t change, the way that your money is applied does. Mortgagors pay more toward interest in the initial stages of repayment; later on, their payments are going more into the loan principal.

So, the mortgage term comes into play when calculating mortgage costs. The basic rule of thumb: The longer the term, the more interest that you pay. Someone with a 15-year term, for example, will pay less in interest than someone with a 30-year fixed-rate mortgage.

Crunching the numbers can be a bit complicated: To determine exactly what a particular fixed-rate mortgage costs—or to compare two different mortgages—it’s simplest to use a mortgage calculator.

You plug in a few details—typically, home price, down payment, loan terms, and interest rate—push the button, and get your monthly payments. Some calculators will break those down, showing what goes to interest, to principal, and even (if you so designate) to property taxes; they’ll also show you an overall amortization schedule, which illustrates how those amounts change over time.

For the Math-Minded

If you’re into crunching numbers, there’s a standard formula to calculate your monthly mortgage payment by hand.

Monthly mortgage interest formula

where:

M=Monthly payment

P=Principal loan amount (the amount that you borrow)

i=Monthly interest rate

n=Number of months required to repay the loan

So, to solve for the monthly mortgage payment (“M”), you plug in the principal (“P”), the monthly interest rate (“i”), and the number of months (“n”).

If you want to calculate the mortgage interest alone, here’s a fast formula for that:

Monthly mortgage interest formula

 

Special Considerations

Most amortized loans come with fixed interest rates, although there are cases where non-amortizing loans have fixed rates, too.

Amortized Loans

Amortized fixed-rate mortgage loans are among the most common types of mortgages offered by lenders. These loans have fixed rates 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.

You can easily calculate an amortization schedule with a fixed-rate interest when a loan is issued. That’s because the interest rate in a fixed-rate mortgage doesn’t change for every installment payment. This allows a lender to create a payment schedule with constant payments over the life of the loan.

As the loan matures, the amortization schedule requires the borrower to pay more principal and less interest with each payment. This differs from a variable-rate mortgage, where a borrower has to contend with varying loan payment amounts that fluctuate with interest rate movements.

Non-Amortized Loans

Fixed-rate mortgages can also be issued as non-amortized 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 a lump sum balloon payment at the end of the loan.

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.

Fixed-Rate Mortgages vs. Adjustable-Rate Mortgages (ARMs)

Adjustable-rate mortgages (ARMs), which have both fixed- and variable-rate components, are also usually issued as an amortized loan with steady installment payments over the life of the loan. They require a fixed rate of 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 the consistent payments with a fixed-rate loan.

ARMs are generally favored by people who don’t mind the unpredictability of rising and falling interest rates. Borrowers who know that they either will refinance or won’t hold the property for a long period of time also tend to prefer ARMs. These borrowers typically bet on rates to fall in the future. If rates do fall, then a borrower’s interest decreases over time.

Advantages and Disadvantages of a Fixed-Rate Mortgage

Varying risks are involved for both borrowers and lenders in fixed-rate mortgage loans. These risks are usually centered around the interest rate environment. When interest rates rise, a fixed-rate mortgage will have lower risk for a borrower and higher risk for a lender.

Borrowers typically seek to lock in lower rates of interest to save money over time. When rates rise, a borrower maintains a lower payment compared to current market conditions. A lending bank, on the other hand, is not earning as much as it could from the prevailing higher interest rates—foregoing profits from issuing fixed-rate mortgages that could be earning higher interest over time in a variable-rate scenario.

In a market with falling interest rates, the opposite is true. Borrowers are paying more on their mortgage than what current market conditions are stipulating. Lenders are making higher profits on their fixed-rate mortgages than they would if they were to issue fixed-rate mortgages in the current environment.

Of course, borrowers can refinance their fixed-rate mortgages at prevailing rates if those rates are lower, but they have to pay significant fees to do so.