Fixed-rate mortgages: What they are, how they work
Buying a home can be fun and exciting. Figuring out the financing details, not so much. Even though housing prices and mortgage rates gyrate over time, one constant buyers can rely on to stay the same is a fixed-rate mortgage.
What is a fixed-rate mortgage?
A fixed-rate mortgage has an interest rate that remains the same for the life of the loan. In other words, your total monthly payment of principal and interest will remain the same over time. (Note: Your mortgage payments can fluctuate, though, if your property taxes or homeowners insurance rates fluctuate.) A fixed-rate mortgage is the most popular type of financing because it offers predictability and stability for your budget.
Fixed-rate mortgages tend to have a higher interest rate than an adjustable-rate mortgage, or ARM. But ARMs have low, fixed rates for a brief period, typically three, five or seven years, before the interest rate resets. After that time, rates can go up or down (as can your monthly payments) for the remainder of the loan term, though most ARMs have a cap.
How long do I repay a fixed-rate mortgage?
The mortgage term is the number of years you repay the loan. Fixed-rate mortgages usually come in terms of 15 or 30 years. Here are some pros and cons of each term:
- For any given loan amount, the monthly payments are lower than a shorter-term mortgage.
- You pay more total interest over the life of the loan compared with a shorter term.
- The interest rate is higher.
- You pay less total interest over the life of the loan.
- The interest rate is lower.
- For a given loan amount, the monthly payments are higher.
Many borrowers prefer a 30-year, fixed-rate mortgage over a 15-year loan because the monthly payment is lower for the same loan amount. Choosing a longer fixed term means you can borrow more money, too. It can also free up your monthly cash flow for other financial goals, such as saving for emergencies, retirement or your child’s college tuition.
A 15-year fixed mortgage is ideal for people who have the cash flow and want to pay off their home faster at less interest. Your monthly payments will be higher, though, because you’re repaying more principal so run the numbers with your lender to ensure you can afford it without skimping on other financial goals.
Similar payments, different amounts
Meet Jill, a first-time buyer with a tight budget. Jill knows she can afford about $1,000 a month in principal and interest. Jill’s lender offers a 30-year fixed with an interest rate of 4.5 percent or a 15-year fixed at 4 percent.
30-year fixed at 4.5 percent: $1,013 monthly principal and interest for a $200,000 loan
15-year fixed at 4 percent: $1,013 monthly principal and interest for a $137,000 loan
For the same monthly payment, Jill can borrow $63,000 more with a 30-year fixed. However, Jill will pay a lot more in interest (keep reading).
Same amounts, different interest
For a $200,000 mortgage:
30-year fixed at 4.5 percent: $164,813 total interest for the life of the loan
15-year fixed at 4 percent: $66,288 total interest for the life of the loan, or $98,525 less
Compare the rates
Find out how much mortgage principal and interest you might pay for a home loan by using a mortgage calculator. Lenders offer the most competitive rates and terms to borrowers with strong credit. Check your free credit score at myBankrate to see where you stand.