A house loan with a fixed interest rate is one that doesn’t alter throughout the course of the loan’s term. When you take out a loan, the interest rate is only a little bit more than the rate on Treasury bonds. Even if Treasury bond yields change, nothing will change.
An interest rate that stays the same for the duration of a loan is known as a fixed-rate mortgage. The lender charges you interest as compensation for lending you the money. The main of the loan, which is the sum you borrowed, is also covered by the monthly payment.
Real estate taxes, homeowners insurance, or mortgage insurance may all be included in your monthly mortgage payment. Only if these costs rise will your pay increase.
Conventional loans and loans backed by the Federal Housing Administration (FHA) or the Department of Veterans Affairs are both examples of fixed-rate mortgages.
How a Fixed-Rate Mortgage Works
The amount due each month is equal to the principal plus a tiny portion of the principal multiplied by the interest rate.The process of paying off a loan over time is called amortization. Each month, a portion of the principal is paid off, which lowers the interest payment due on the balance of the principal. As a result, a larger portion of each month’s payment is applied to the principle.
In other words, at the start of the loan, interest makes up the majority of the monthly payment. Most of it eventually goes to the principal. Utilize our loan amortization calculator to see how far your monthly payments go toward paying the interest and recouping the principal balance over time.
How Interest Rates Are Determined
At the time the mortgage is issued, the interest rate is often just a tiny bit higher than the yield of the 30-year Treasury bond. When seeking a more lucrative investment than Treasury bonds without taking on excessive risk, investors purchase mortgages on the secondary market. Mortgage rates are impacted in this way by Treasury notes.
Since 1985, interest rates have been generally declining. One explanation for this is because the Federal Reserve has subsequently maintained a low level of inflation. Low rates on Treasury bonds are the result of this. As a result, 30-year fixed-rate mortgage interest rates have been below 7% since March 2002. The average 30-year fixed mortgage rate is 2.86 percent as of September 11, 2020, which is a record-low.
The graph below shows the evolution of interest rates for 15-year and 30-year fixed-rate mortgages from the year 2000 to the present.
Although the average mortgage rate is at an all-time low as of September 2020, it’s vital to keep in mind that your particular mortgage’s interest rate will depend on your credit rating, income, and other financial factors.
Types of Fixed-Rate Mortgages
There are three types of fixed-rate mortgages.
5/1 Adjustable Rate Mortgage
A five-year fixed-rate mortgage serves as the foundation for a 5/1 ARM. It varies based on current interest rates after the first five years.
A so-called fixed-rate mortgage that only has a fixed rate for the first five years is what some mortgage brokers will try to sell you. Make sure you inquire about the interest rate once that term has passed.
The initial interest rate is lower than that of a 30-year mortgage, which is an advantage. What happens after five years is the drawback. Depending on current rates, your interest rate can rise quickly. If you want to sell within five years or think interest rates will go down, this loan can be a suitable choice.
For the entire 15-year term of a 15-year fixed-rate mortgage, the interest rate is fixed. Because you pay down more of the principle with each payment, it can be appealing to homeowners. This implies that you can pay off the principal more quickly than you could with a typical 30-year loan. Additionally, equity grows faster.
On the other side, monthly payments for 15-year mortgages are greater. As a result, if your income decreases, there is a slightly increased danger of default.
The cheapest conventional loan is a 30-year mortgage. Due to the 30-year payback period, the monthly payment is cheaper than a loan with a 15-year term. If you intend to live in your house for a long period, this loan can be a smart choice. Families with lesser earnings benefit from it as well because it enables them to purchase a property for a reduced monthly payment.
The federal government has set a limit amount for conforming loans. Through Freddie Mac or Fannie Mae, the government provides insurance for them. They may therefore cost a little less than non-conforming loans.
The Federal Housing Administration oversees and insures FHA mortgages. Borrowers are allowed to have poorer credit scores and put down less money than they would for a conventional loan.
Alternatives to Fixed-Rate Mortgages
A no-cost loan, in which the closing fees are essentially rolled into the loan itself, or adjustable rate mortgages, where the interest rate can change over time, are alternatives to a fixed-rate mortgage. With the latter, you can end up paying more over the course of the loan because interest is charged on the closing costs. An adjustable-rate mortgage could result in higher payments if the rate rises beyond the first fixed-rate period. However, if the rate falls, you can end up paying less per month.
Pros and Cons of Fixed-Rate Mortgages
- Unless taxes or insurance increase, the monthly payment remains the same.
- Each month, you repay a portion of the loan’s principle.
- shields you against future hikes in interest rates
- If taxes or insurance increase, the monthly payment does not.
- Monthly, you make a portion of the loan principal payment.
- safeguards you against potential interest rate hikes
The fixed-rate mortgage has the benefit of having a consistent monthly payment. It is simpler to prepare your budget because of this predictability. In contrast to an adjustable-rate mortgage, you won’t need to be concerned about potential increases in payments. Each month, a portion of the principal is paid off. Your home equity is immediately increased as a result. Only if your real estate taxes—which you pay through your monthly mortgage payment—increase or if the cost of your homeowner’s insurance does as well.
The drawback of a fixed-rate mortgage is that it may have a higher interest rate than an interest-only or adjustable-rate loan. In the event that interest rates stay the same or decrease in the future, it becomes more expensive.
Another drawback is that principal repayment is slower than with an adjustable-rate loan. The initial years’ contributions are mostly used to pay interest. These are therefore bad if you intend to sell your home in the next five to ten years.
Additionally, you might have trouble being approved for fixed-rate loans and your closing fees can be higher than they would be for an adjustable-rate loan. Both of these are due to the possibility of financial loss for banks should interest rates increase. They are taking a significant risk by agreeing to a 30-year loan because banks want to be compensated for that risk. An adjustable-rate mortgage can be a better choice if you want to relocate in five years or fewer.
How to Get a Fixed-Rate Mortgage
Almost any bank, credit union, or mortgage provider will let you apply for a fixed-rate mortgage. Comparison shopping among businesses is recommended. You can investigate interest rates with the help of a fantastic tool from the Consumer Financial Protection Bureau (CFPB). Additionally, you want to evaluate fees, points, and closing costs. See if mortgage insurance is necessary as well.
To ensure your safety, request a suitable mortgage. You will be safeguarded against risky elements like negative amortization, balloon payments, and excessive points and fees.
- A fixed-rate mortgage is a house loan in which the interest rate is fixed at the outset and does not change.
- Typical 30-year fixed-rate mortgages and 15-year mortgages are both common options. The first five years of a 5/1 adjustable-rate mortgage, however, are fixed-rate periods.
- The FHA and Department of Veterans Affairs, as well as banks, credit unions, and mortgage lenders, all provide fixed-rate mortgages.