What Is a Fixed Interest Rate?
A fixed interest rate is an unchanging rate charged on a liability, such as a loan or a 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 that combine fixed rates for some portion of the term and adjustable rates through the balance of the term are referred to as "hybrids."
Understanding Fixed Interest Rates
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.
[Important: The interest rates on specified fixed-rate loans remain the same during the life of the mortgage so the borrowers' payments also stay the same, making it easier to budget for the future.]
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 this point. This doesn't happen with a fixed-rate loan that's not designated as a hybrid.
Imagine the bank gives a borrower a 3.5% introductory rate on a $300,000 30-year mortgage with a 5/1 hybrid ARM. His monthly payments are $1,347 during the first five years of the loan, but they'll 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 to $1,799, which might be hard to manage. But the monthly payments would fall to $1,265 if the rate dropped to 3%. The borrower would face the exact same $1,347 payment every month for 30 years if the 3.5% rate was fixed. His monthly bills might vary as his property taxes change or his homeowner's insurance premiums adjust, but his 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. The vast majority of consumers opt for fixed-rate loans.
- 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.
Advantages and Disadvantages of Fixed Interest Rates
Fixed rates are typically higher than adjustable rates, but 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.
The Consumer Financial Protection Bureau (CFPB) provides a range of interest rates you can expect at any given time depending on your location. The site is updated biweekly, and you can input information like 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.