What is a Fixed-Rate Mortgage


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What is a Fixed-Rate Mortgage?

A fixed-rate mortgage is a mortgage loan with an interest rate that stays the same over the course of the loan. Fixed-rate loans are overwhelming the most common type of home loan borrowers get.

With a fixed-rate mortgage loan, you lock in your interest rate for the life of the loan and don’t have to worry about the mortgage rate or payment changing.

Pros and Cons of Fixed-Rate Mortgages

Pros

  • The interest rate will never increase
  • Mortgage payment never changes
  • Many different term lengths to choose from

Cons

  • Higher interest rate than an adjustable-rate mortgage
  • Higher monthly payment than with an ARM
  • The rate will never decrease even if mortgage rates fall.

 

Adjustable-Rate Mortgage Loans

An adjustable-rate mortgage (ARM) is a loan term that starts with a low introductory rate for a fixed period of time that adjusts afterward.

The most common type of adjustable-rate mortgage is a 5/1 ARM.

The first number represents the number of years the initial rate is locked in for, in this case, 5 years. The second number is the number of years the rate can adjust thereafter.

A 5/1 ARM has a low teaser rate locked in for the first 5 years that adjusts annually afterward.

Pros and Cons of Adjustable-Rate Mortgages

Pros

  • Lower rate than fixed-rate mortgages
  • Save a lot of money in interest.
  • Lower monthly mortgage payment
  • Can afford to purchase a more expensive home

Cons

  • Interest rate may increase.
  • Monthly payments will increase over time.
  • May have to refinance once the teaser rate expires.

 

What’s Better, Fixed-Rate, or Adjustable-Rate Mortgage?

Both types of loan terms have their own advantages and disadvantages. Your own personal situation will determine if a fixed-rate or adjustable-rate mortgage is best for you.

If you plan on living in the home for more than 5 years, then a fixed-rate mortgage is a better option. However, if you plan on selling the home within the first 5 years, you can save a lot of money by getting an ARM.

When a fixed-rate loan is best

  • Interest rates are at all-time lows
  • You plan on staying in the home for more than 5 years.
  • You’re self-employed, or your income is not consistent.
  • You plan on paying off the home within 5 years.

When an adjustable-rate loan is best

  • You plan on selling the home within 5 years.
  • You expect an increase in your income.
  • Current rates are unusually high and expected to fall.

 

Comparing Fixed-Rate vs. Adjustable-Rate Loans

To really compare the two types of loan terms, let’s look at an example.

Let’s say you need a mortgage for $250,000 to purchase a new home.

You have two options:

  • A 30-year fixed-rate mortgage with a 5% interest rate – Payment: $1,625
  • A 5/1 ARM with a 4% interest rate – Payment: $1,476

With the fixed-rate mortgage, you will have a monthly mortgage payment of $1,625.

The 5/1 ARM monthly payment is $1,476. That’s $149 per month cheaper—a total of $8,940 cheaper over the first 5 years of the loan.

Types of Fixed-Rate Mortgages

There are a few lengths of fixed-rate terms you can choose from. The shorter the term, the lower the rate will be.

  • 10-year – This term is the shortest available; it offers the lowest rate you can get with a fixed-rate and has the highest monthly payment.
  • 15-year – 15-year fixed-rate mortgage loans are becoming more popular because they have lower interest rates than 30-year loans and will save you tens of thousands of dollars over the life of the loan.
  • 30-year – The 30-year fixed-rate mortgage loan is the most popular loan term used in the U.S. It features an average interest rate with reasonable monthly payments
  • 40-year – This is a new loan term that is offered by some lenders. It provides the lowest monthly mortgage payment; however, it will have the highest interest rate.

 

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