WHAT IS A FIXED RATE MORTGAGE?
Understanding Fixed Rate Mortgages
When it comes to mortgage interest rates, your loan can come in one of two flavors: fixed or adjustable.
As you prepare for the home buying process, you’ll need to decide which flavor makes the most sense for you: a fixed-rate or an adjustable rate mortgage loan? While there are benefits to both, fixed-rate mortgages tend to be very popular among borrowers for their stability.
But before you can decide whether a fixed-rate mortgage makes sense for you, you need to know the basics about what these types of mortgages are and how they work.
IN THIS ARTICLE WE WILL CONSIDER:
- What Is A Fixed-Rate Mortgage?
- Fixed-Rate Mortgage Terms
- Fixed-Rate Mortgage Vs. Adjustable Rate Mortgage (ARM)
- Is A Fixed-Rate Mortgage Right For You?
What Is A Fixed-Rate Mortgage?
When it comes to fixed-rate mortgages, the name says it all. When you get one of these mortgages, your interest rate will remain the same for the entire time you’re paying off the loan. In other words, the interest rate is fixed.
The main benefit of a fixed-rate mortgage is that your monthly mortgage payment will remain the same throughout the life of the loan, with one caveat: if your homeowners insurance premium or property taxes go up or down, your payments will change to reflect your new costs. But with a fixed-rate mortgage, the amount you pay toward the mortgage itself, the part that’s made up of your principal and interest, won’t change.
Fixed-rate mortgages typically come with slightly higher rates than ARMs. However, once the lower introductory rate period on an ARM is over, your rate could increase, causing your monthly payments to go up. If your rate continues to increase, you could end up paying substantially more than what you initially paid.
As you learn about fixed-rate mortgages, another term you should be familiar with is amortization. Mortgage loans typically have a set length of time that dictates when they’ll be paid off. For example, you may have a 30-year fixed-rate mortgage, which means that after 30 years of monthly payments, your mortgage will be fully paid off.
To achieve this, your lender spreads out your payments according to an amortization schedule, which is a plan for how and when your loan will be paid off. Because your payment amount is the same each month, the amount of principal and interest you pay changes with each payment.
In the first few years of making mortgage payments, the majority of your payment will be paying off interest, rather than being put toward the principal (the original loan amount). For example, say you have a fixed-rate loan with a monthly payment of $800. When you first begin paying off your mortgage, you’ll pay the full $800, but $600 of it might go toward interest while only $200 goes toward paying off the principal. But as you progress through the life of your loan, the balance changes. At one point, you may pay an equal amount in interest and principal. By the end of your loan’s amortization schedule, you’ll be paying mostly principal and very little in interest; for example, maybe you pay $750 toward the principal and only $50 in interest.
Fixed-Rate Mortgage Terms
A loan’s term refers to how long you’ll be paying it off. The most common loan terms for fixed-rate mortgages are 30 years and 15 years, both with their own pros and cons.
Thirty-year fixed-rate mortgages tend to be the most popular option for borrowers. Because the loan term is so long, you can keep your monthly payments nice and low, even with a slightly higher interest rate. Though borrowers can save money on interest by going with a shorter term, 30-year loans often present the most affordable option for those who are more concerned about keeping their monthly housing costs down than the overall costs over the loan’s lifespan.
If you’re considering a 30-year mortgage term, think about what’s more important: lower monthly payments, or paying off your loan faster and paying less in interest over the life of the loan? You can check this using our mortgage calculator.
When you opt for a 15-year mortgage term, you’ll save quite a bit of money on interest. Not only do 15-year loans typically have lower rates than 30-year loans, but because the loan has a shorter amortization period, you’ll save even more on interest. This holds true even if you were to have the same interest rate on both a 15-year loan and a 30-year loan. Let’s look at an example of this.
Say you get a mortgage for $200,000 with an interest rate of 4%. With a 30-year fixed-rate mortgage, not only will you pay back the original $200,000, you’ll also pay around $143,739 in interest over the life of the loan. Take the same situation, but swap the 30-year for a 15-year loan. On the 15-year, the total interest paid will be around $66,288.
Seems like the 15-year is the obvious choice, right? Don’t forget to consider your monthly payment. On the 15-year loan, your monthly payment would be around $1,479, not including taxes and insurance. With the 30-year loan, your monthly payment would be a significantly more affordable $955.
If you can afford the larger payments and are most interested in building equity and paying off your home quickly, the 15-year may be a better choice. It just depends on what your finances can comfortably handle.
Other Fixed-Rate Mortgage Terms
Depending on the lender, you may also find other loan terms that better fit your needs. Perhaps you’d like a loan that balances the affordability of a 30-year term with the interest-saving benefits of a 15-year. Twenty-year terms are a good example of this and are another popular option for borrowers, though not as commonly touted as the 15- or 30-year.
Fixed-Rate Mortgage Vs. Adjustable Rate Mortgage (ARM)
The question of whether you should opt for a fixed-rate mortgage or an ARM depends on a few different factors.
As we’ve seen, fixed-rate mortgages are great for stability. If you don’t want to have to worry about your monthly payments changing down the road, a fixed-rate loan can make a lot of sense. They can also be a good choice if interest rates are currently relatively low. Even though fixed-rate mortgages will have higher rates than the introductory rate you’ll get on an ARM, you have the confidence of knowing you’ll have a low rate locked in for the entire time you’re paying off the loan.
On the other hand, the low introductory rate on an ARM can be very attractive, especially if you don’t plan on remaining in your home for a long time. Typically, your introductory rate remains fixed for the first 5, 7 or 10 years you have the loan. If you know you’ll be selling your house before your rate adjusts, you can save money by opting for an ARM. Plus, if interest rates are currently relatively high, an ARM can help you get a lower rate.
Is A Fixed-Rate Mortgage Right For You?
Ultimately, the type of mortgage you choose will depend on your own financial situation, and what you’re comfortable with. If you’re ready to get started with the mortgage process, you can fill out the form below to be connect with a certified loan professional who can help you make a wise financial decision.
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