What Is a Fixed Interest Rate?
A fixed interest rate is an unchanging rate charged on a liability, such as a loan or mortgage. It might apply during the entire term of the loan or for just part of the term, but it remains the same throughout a set period. Mortgages can have multiple interest-rate options, including one that combines a fixed rate for some portion of the term and an adjustable rate for the balance. These are referred to as “hybrids.”
- A fixed interest rate avoids the risk that a mortgage or loan payment can significantly increase over time.
- Fixed interest rates can be higher than variable rates.
- Borrowers are more likely to opt for fixed-rate loans during periods of low interest rates.
How Do Fixed Interest Rates Work?
A fixed interest rate is attractive to borrowers who don’t want their interest rates fluctuating over the term of their loans, potentially increasing their interest expenses and, by extension, their mortgage payments. This type of rate avoids the risk that comes with a floating or variable interest rate, in which the rate payable on a debt obligation can vary depending on a benchmark interest rate or index, sometimes unexpectedly.
The interest rate on a fixed-rate loan remains the same during the life of the loan. Because the borrower's payments stay the same, it's easier to budget for the future.
How to Calculate Fixed Interest Costs
Calculating fixed interest costs for a loan is relatively simple. You just need to know:
- The loan amount
- The interest rate
- The loan repayment period
So, assume that you're taking out a $30,000 debt consolidation loan to be repaid over 60 months at 5% interest. Your estimated monthly payment would be $566 and your total interest paid would be $3,968.22. This assumes you don't repay the loan early by increasing your monthly payment amount or making lump-sum payments toward the principal.
Here's another example. Say you get a $300,000 30-year mortgage at 3.5%. Your monthly payments would be $1,347 and your total mortgage costs with interest included would come to $484,968.
Online loan calculators can help you quickly and easily calculate fixed interest rate costs for personal loans, mortgages, and other lines of credit.
Fixed vs. Variable Interest Rates
Variable interest rates on adjustable-rate mortgages (ARMs) change periodically. A borrower typically receives an introductory rate for a set period of time—often for one, three, or five years. The rate adjusts on a periodic basis after that point. Such adjustments don’t occur with a fixed-rate loan that’s not designated as a hybrid.
In our example, a bank gives a borrower a 3.5% introductory rate on a $300,000, 30-year mortgage with a 5/1 hybrid ARM. Their monthly payments are $1,347 during the first five years of the loan, but those payments will increase or decrease when the rate adjusts based on the interest rate set by the Federal Reserve or another benchmark index.
If the rate adjusts to 6%, the borrower’s monthly payment would increase by $452 to $1,799, which might be hard to manage. But the monthly payments would fall to $1,265 if the rate dropped to 3%.
If, on the other hand, the 3.5% rate were fixed, the borrower would face the same $1,347 payment every month for 30 years. The monthly bills might vary as property taxes change or the homeowners insurance premiums adjust, but the mortgage payment remains the same.
Fixed-rate loans can be counted on, whereas there’s always a bit of uncertainty associated with variable interest rates.
Advantages and Disadvantages of Fixed Interest Rates
Fixed interest rates can offer both pros and cons for borrowers. Looking at the advantages and disadvantages side by side can help decide whether to choose a fixed- or variable-rate loan product.
More attractive when interest rates are low
Easier to calculate long-term costs of borrowing
May be higher than adjustable rates
If rates decline, you may pay more for your loan
Refinancing to a lower rate can be time-consuming and expensive
- Predictability. Fixed interest rates offer predictability in that your monthly loan payments stay the same month to month.
- Low rates. When interest rates are low or near historic lows, a fixed interest rate loan product can become more attractive.
- Calculate costs. A fixed interest rate on a loan or line of credit makes it easier to calculate the lifetime cost of borrowing because the rate doesn't change.
- Higher than adjustable rates. Depending on the overall interest rate environment, it's possible that a fixed-rate loan may carry a higher interest rate than an adjustable-rate loan.
- Declining rates. If interest rates decline, you could be locked into a loan with a higher rate, whereas a variable rate loan would keep pace with its benchmark rate.
- Refinancing. Refinancing from one fixed-rate loan to another or to a variable-rate loan could save money when rates drop, but it can be time-consuming, and closing costs can be high.
Fixed rates are typically higher than adjustable 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 when interest rates are high.
Borrowers are more likely to opt for fixed interest rates during periods of low interest rates when locking in the rate is particularly beneficial. The opportunity cost is still much less than during periods of high interest rates if interest rates go lower.
Remember that your credit scores and income can influence the rates you pay for loans, regardless of whether you choose a fixed- or variable-rate option.
The Consumer Financial Protection Bureau (CFPB) provides a range of interest rates you can expect at any given time depending on your location. The rates are updated biweekly, and you can input information such as your credit score, down payment, and loan type to get a closer idea of what fixed interest rate you might pay at any given time and weigh this against an ARM.