What is a fixed-rate mortgage?
A fixed-rate mortgage is a financial product that has a constant interest rate for the life of the loan.
Borrowers commonly encounter two types of mortgages: the fixed-rate mortgage and the adjustable-rate mortgage.
The fixed-rate mortgage has a multitude of term options that vary from 10 to 30 years. Regardless of your preferred length, the interest rate remains the same for the length of the mortgage. This makes the fixed-rate mortgage a popular choice for homeowners who prefer a stable, budget-friendly monthly payment.
The interest rate for an adjustable-rate mortgage fluctuates over the course of the loan. An adjustable-rate mortgage, or ARM, ties the interest rate to a margin that includes a stated index, such as the Libor or Treasury bill yield. It includes the index plus a spread. While the index changes, the spread remains the same.
The loan adjusts periodically based on the terms of the mortgage. Should interest rates increase, the borrower has to adjust his budget to accommodate the higher payment.
Since the principle and interest remain the same for a fixed-rate mortgage, it is ideal for borrowers on a budget who don’t want to contend with payment adjustments. However, should interest rates drop, borrowers cannot take advantage of the drop unless they refinance the mortgage.
If a borrower places the property tax and homeowner’s insurance payments in escrow the fixed-rate mortgage payment can increase. This is due to fluctuations in taxes and insurance, not the interest rate.
Fixed-rate mortgage example
Jane is shopping for a home and doesn’t want her mortgage payment to fluctuate. She wants to purchase a $200,000 home, with a down payment of $10,000. A 30-year fixed-rate mortgage, with an interest rate of 5 percent, has a monthly payment of $1,019.96 (principle and interest only). This portion of her mortgage remains the same over the entire life of the loan.
Trying to decide between multiple loans? Run the numbers and see which mortgage is right for you.