A fixed-rate mortgage (FRM) can provide you with security and stability, but make sure you compare several loans on the market before reaching a decision
A fixed-rate mortgage (FRM) can give you peace of mind by protecting you from interest rate increases. A FRM also provides you with consistent monthly payments which can help with your personal budgeting.
Fixed-rate mortgages are the most common type of housing loan in America. While a fixed rate mortgage can be useful for borrowers who are risk-averse and intend to stay in their home for a long period of time, ensure that you compare the full benefits and risks of FRMs before signing the paperwork.
What is a fixed-rate mortgage (FRM)?
A fixed-rate mortgage has an interest rate that remains unchanged for the life of the loan. This means that monthly payments on a fixed-rate mortgage remain identical for the loan term. This is appealing for borrowers who want the security of a fixed rate and also for those who intend to stay in their home for an extended period of time. As the rate is locked in, changes in the market won’t affect your monthly payments.
For example, if you took out a loan of $400,000 at 6.5% interest over a 30-year period, you would have standard monthly payments of $2,528.27.
FRMs are available with 15, 20, and 30-year loan terms. They typically require a down payment of 5-20%.
How is the fixed-rate interest calculated?
Banks use several factors to set the interest rate for fixed-rate mortgage products. The United States Federal Reserve determines the bank reserve requirements which your lender will observe when setting the interest rate.
Banks will also take into account the prime rate and the level of competition within the market. Banks will also consider economic factors such as inflation, the demand for money throughout the country, and stock market levels.
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Pros and cons of a fixed-rate mortgage (FRM)
- Consistent payments. As the rate on a fixed rate mortgage does not change throughout the life of the loan, you can predict what your monthly payments will be which can help with cash flow, budget, and lifestyle management.
- Simplicity. FRMs are generally easier to compare than adjustable-rate mortgages (ARMs) as the math is more straightforward and you don’t have to consider the complex indexes and margins associated with ARMs.
- Protected from rate rises. If you have an FRM for a long period of time and rates increase, then you won’t be at risk of defaulting on your loan due to higher payments. Conversely, if rates fall then you can refinance.
- Ability to pay down principal. Most FRMs don’t have restrictive prepayment penalties, so you can make extra payments towards the principal without incurring penalty.
- Protected from inflation. Regardless of changes to inflation in the market, your interest rate will remain stable throughout your loan term.
- Up-front costs. Closing costs such as origination fees and underwriting fees are often higher for FRMs compared to other types of loans.
- Market risk. You won’t benefit from any interest rate falls.
- Higher rates. FRMs typically come with higher average introductory interest rates compared to those offered during the initial period for ARMs.
- More difficult to qualify. Due to higher up-front costs and a higher comparable interest rate, those borrowers with poor credit or a small down payment may find it difficult to qualify for a FRM.
Am I suited to a fixed-rate mortgage? (FRM)
Although this will depend on a myriad of factors and your personal situation, generally FRMs are good when:
- Current rates are low. If current interest rates are low, it may be a good time to lock in a competitive rate.
- You plan to stay put. If you intend to live in your property for an extended period of time, the upfront charges may make it more cost-effective over a longer loan term.
- You have good credit. The lender may need you to provide evidence of a savings history and financial discipline in order to demonstrate that you can commit to your monthly payments over an extended period, such as 30 years.
- You value stability. FRMs may be suited for borrowers who are risk-averse and prefer to have stability, certainty, and consistency of their monthly payments.
- You need to budget. By virtue of their fixed monthly payments, FRMs are predictable which helps a borrower arrange their personal budget.
How does the loan term of an FRM influence interest and equity?
Generally the longer the term of the fixed-rate mortgage, the more interest you pay over the life of the loan and the lower your monthly payments. Conversely, the shorter the loan term, the lower the interest rate will be and the faster you’ll pay off the loan and build equity in your home. However your monthly payments will tend to be higher in this case.
30-year fixed rate mortgage
The 30-year fixed-rate mortgage is one of the most popular types of conventional fixed mortgages in the US. However, keep in mind that although your monthly payments may be lower, you’ll pay more interest over the life of the loan.
While a 30-year fixed-rate mortgage protects you from changing market conditions that may increase your payments, it also means you’re unable to take advantage of lower interest rates unless you refinance.
A 30-year fixed rate mortgage can be useful when:
- You intend to stay in the home for a long period of time.
- You believe interest rates will increase.
- You don’t expect your income to increase in the near future.
20-year or 15-year fixed-rate mortgage
Although your monthly payments may be higher with a 20-year or 15-year fixed rate mortgage, you’ll pay less overall interest on the loan due to the shorter loan term. You’ll be able to pay off your loan sooner.
While a 20-year or 15-year fixed-rate mortgage provides you with consistent interest payments for the entire duration of the loan, your monthly payment will work out to be around 10-15% higher than a 30-year standard fixed mortgage.
A 20-year or 15-year fixed-rate mortgage may be useful when:
- You plan to retire within 20 years or less.
- You want to own your home quickly.
Frequently asked questions