What Is a Fixed-Rate Mortgage?
A fixed-rate mortgage is one of the two major types of mortgages. Unlike adjustable-rate mortgages (ARMs), which feature mortgage rates that can change over time, the rate of interest charged on fixed-rate mortgages stays the same throughout the life of the loan.
With a fixed-rate mortgage, payments throughout the loan term are pre-defined and predictable, and various repayment periods are available depending on the borrower's needs. Fixed-rate mortgages are especially useful for locking in affordable mortgage rates in a low-rate environment, but they don't allow borrowers to benefit automatically if prevailing interest rates fall in the future.
Key Attributes of a Fixed-Rate Mortgage
- The mortgage rate stays the same for the life of the loan: The key feature of the fixed-rate mortgage is that the interest rate the lender and borrower initially agree to never changes. The borrower doesn't need to worry about changes in prevailing interest rates, as the fixed-rate mortgage essentially locks the initial rate in for as long as the loan is outstanding.
- Monthly payments are predictable: Because monthly payments are tied to the interest rate on the mortgage, the amount you pay never changes throughout the life of the loan. As the loan principal declines, the portion of each monthly payment going toward loan interest drops, leaving more money to go toward paying down the principal amount of the mortgage.
- Different terms are available: The most popular terms on fixed-rate mortgage involve repayment over 30-year or 15-year periods. However, some lenders offer terms as long as 40 years, while other lenders offer 10-year, 20-year, or other customized repayment options.
Pros and Cons of Fixed-Rate Mortgages
- Why fixed-rate mortgages are attractive: Once the borrower gets a fixed-rate mortgage, there's no risk that the mortgage rate or the monthly payments under the loan will ever go up. As a result, if the borrower can afford the initial payments, then it's likely that all future payments will remain affordable, reducing the risk of default or foreclosure.
- Why fixed-rate mortgages aren't always best: Interest rates on fixed-rate mortgages are often higher than on adjustable-rate mortgages, forcing fixed-rate mortgage borrowers to pay higher monthly payments. In addition, if prevailing interest rates fall, fixed-rate mortgage borrowers don't see their mortgage rate change, leaving them without the benefit that adjustable-rate mortgage borrowers get from lower rates.
Fixed-rate mortgages offer the reliability and predictability of knowing exactly what you'll owe throughout the life of the mortgage. Especially when there's a threat of higher rates in the future, fixed-rate mortgages can end up saving you money in the long run.
The article What Is a Fixed-Rate Mortgage? originally appeared on Fool.com.
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