If you’re considering buying a home or refinancing your current mortgage, you might be wondering if a fixed-rate mortgage is right for you.
Fixed-rate loans are popular choices. More than 95% of homebuyers chose fixed-rate over adjustable-rate mortgages (ARM) late last year.
According to ICE Mortgage Technology, ARMs accounted for just over 4% of all mortgages in September 2021.
If you’re planning to buy a home in the near future, it’s important to understand how fixed-rate loans work and whether it’s the best choice for your family.
How does a fixed rate mortgage work?
Before diving into how fixed-rate mortgages work, it’s important to understand what a fixed-rate loan really is.
Fixed-rate mortgage definition
A fixed-rate loan is any home loan that offers an interest rate that remains the same for the loan’s lifetime. They account for the majority of mortgage loans issued in the United States.
Fixed-rate mortgages offer the convenience of having relatively consistent payments. With a fixed-rate mortgage, your loan’s principal and interest payments remain the same for the entire loan term.
How fixed-rate mortgages work
A portion of your monthly payment covers both interest and principal with fixed-rate mortgages. Because of this, borrowers have fully repaid their loan—principal and interest—when the term ends.
Most of the payment covers the interest portion in the early years, but as the principal amount decreases, so does the amount of interest you pay.
Later in the mortgage term, most of each monthly payment pays the principal, with only a tiny amount going toward interest.
How are fixed interest rates determined?
Interest rates are usually slightly more than a 30-year Treasury bond yield when the mortgage is issued. As a result, investors looking for products offering a greater return than a Treasury bond—without significant additional risk—typically mortgages on the secondary market.
Fixed-rate mortgages vs. adjustable-rate mortgages
The primary differences between a fixed-rate mortgage and an adjustable-rate mortgage center around the interest rate.
An adjustable mortgage generally offers borrowers an initial interest rate that is lower than a fixed-rate mortgage—but it’s temporary.
Once the introductory rate period expires, an ARM’s interest rate can rise. While borrowers are protected to a degree—ARMs have a rate increase limit—the interest can still jump significantly, putting homeowners in a vulnerable financial situation if the rate jumps more than they had budgeted for.
Conversely, a fixed mortgage offers borrowers a single “fixed” interest rate for the lifetime of their loan. The interest rate homeowners pay during the first months will be the same as their last payment.
A fixed interest rate only changes when homeowners refinance their mortgage into a new home loan with different rates or terms.
It’s worth noting that some homeowners with a fixed-rate mortgage can see fluctuations in their monthly mortgage amount due to changes to homeowners insurance or property taxes change. Insurance and taxes are often combined with mortgage payments in escrow.
Advantages and disadvantages of a fixed-rate mortgage
Fixed mortgages offer several advantages—and disadvantages— for potential homebuyers.
Advantages of fixed mortgages include
- Consistent interest rates and monthly mortgage payments make budgeting more manageable, allowing many homeowners to handle their finances with greater ease and predictability, knowing payments will remain constant years into the future.
- Fixed mortgages don’t have a steep learning curve; they’re relatively straightforward, making them more accessible for many first-time homeowners.
Disadvantages of fixed-rate mortgages include
- If mortgage interest rates drop to less than you’re currently paying, you’ll have to refinance your current mortgage to take advantage of the new lower interest rate. (You’ll also have to pay any closing costs and borrowing fees.)
- Because a fixed mortgage is any mortgage with a consistent interest rate, each mortgage can come with different eligibility requirements. For example, FHA loans are popular with borrowers with imperfect credit scores, while conventional loans often appeal to borrowers with larger down payments.
How long does it take to repay a fixed mortgage?
The length of time it takes to repay your fixed mortgage will depend on your specific mortgage terms.
The most common fixed-rate loan selected by borrowers is a 30-year mortgage term, meaning borrowers have 30 years to pay off the loan amount. That might sound like a long time, but it’s worth remembering you’ll pay the same rate for all monthly payments over those 30 years once your mortgage is finalized.
Another popular choice is the 15-year fixed-rate mortgage. This can be an excellent choice for borrowers hoping to lock in a lower interest rate but pay off their homes sooner.
While 15-year-mortgages and 30-year-mortgages are popular, they aren’t your only choices for fixed-rate mortgages. Many mortgage lenders offer customizable terms ranging between eight and 29 years.
Is a fixed interest rate right for you?
Fixed-rate mortgages can be a great tool for some homeowners, but no one mortgage is suitable for every financial situation.
Some situations where choosing a fixed-rate mortgage can be beneficial include,
You have long term goals. If you plan on living in your home for ten years or longer, fixed-rate mortgages are often a preferred choice because you don’t have to concern yourself with market fluctuations. You can concentrate on living your best life.
Current mortgage interest rates are low. A fixed mortgage when rates are low is ideal for locking in that low rate for the lifetime of your home loan.
You want to avoid unnecessary financial risks. Because ARM rates come with an inherent risk of a higher interest rate during the life of your ARM home loan, it can mean more stress managing your money.
If you’d rather fix it and forget it without additional risk, a fixed mortgage might be the right choice for your financial situation.
Contact Assist Home Loans for your next purchase or refinance
Fixed-rate mortgages offer a number of advantages. They can be a good choice for many homebuyers, depending on your financial situation and home buying goals.
To make the best mortgage choice, take some time to ask questions and find out about the different home loan products you can apply for.
We’ll walk you through everything you need to know about fixed-rate mortgages and help you decide whether it’s the best choice for your family.