Fixed Rate Mortgage
A fixed rate mortgage is a home loan that has the same interest rate for the entire loan term.
What is a fixed rate mortgage?
A fixed rate mortgage has a fixed interest rate for the entire life of the loan term. Consequently, your monthly payment of principal and interest will also remain the same throughout the life of the loan. Most fixed rate loans are conventional loans or FHA loans, which are guaranteed by the Federal Housing Authority.
The most common types of fixed-rate mortgages are a 30-year fixed loan and a 15-year fixed loan. A 30-year fixed mortgage is best for those who prefer the same interest rate but want a lower monthly payment than a 15-year loan. With a 15-year fixed mortgage, you pay off your loan faster and pay less interest overall. However, your monthly payment is higher.
How does a fixed rate mortgage work?
In general, fixed-rate mortgages are amortized loans. In other words, there is a specific schedule of payments that apply to the principal and interest. As the loan matures, the borrower pays more towards the principal balance and less towards the interest.
Let’s say that you want to purchase a $200,000 home. You have a 20% down payment, or $40,000. Fortunately, you secure a 4.3% interest rate for a 30-year fixed mortgage. Your estimated monthly fee is $993, including property tax and homeowner’s insurance.
Excluding taxes and insurance, $795 of your monthly payment is going towards the loan’s principal and interest. In the first month, only $217 actually goes towards the principal, whereas $578 goes towards interest. You will continue to pay $795 towards your mortgage every month.
However, by month 120, or 10 years into your 30-year fixed mortgage, now $333 is going towards the principal and $461 towards the interest. Going forward, by month 360, or the last month of your mortgage, $790 goes towards the principal and $3 goes toward the interest.
The main advantage of a fixed rate mortgage is predictability and stability. You know the interest rate and exactly how much you pay off your principal each month. Your monthly payment is always the same, excluding any variation in property taxes or homeowners insurance rates.
Unlike an interest-only loan, every payment you make increases your home equity.
The interest rate on a fixed-rate mortgage is higher than an adjustable-rate or an interest-only loan. If interest rates stay the same or decrease, your mortgage is more expensive compared to other loans.
Slower Rate to Build Equity
Most fixed-rate mortgages follow an amortization schedule. As a result, it takes longer to build equity in your home because you pay off the principal at a slower rate. Majority of your payments initially go towards interest. This type of loan is not advisable if you intend to sell your home within five to ten years.
Eligibility and Closing Costs
Because you secure the same interest rate for 15 or 30 years, the banks are taking a risk and may lose money if interest rates increase. As a result, it is generally more difficult to qualify for fixed-rate loans, and you will likely pay higher closing costs for this type of conventional mortgage.