What is a fixed-rate mortgage and how does it work?
Key takeaways
- A fixed-rate mortgage has a consistent interest rate and a predictable monthly payment throughout its entire term.
- Most mortgages in the U.S. are fixed-rate mortgages.
- Within the category of fixed-rate loans, there are multiple options, including conventional and government-backed loans.
What is a fixed-rate mortgage?
A fixed-rate mortgage has an interest rate that remains constant throughout the entire loan period, or term. That means your monthly payment for principal and interest stays the same. Keep in mind that additional costs, like homeowners insurance and property taxes, may cause slight variations in your total monthly payment.
While 30-year terms are the most common, 20-year, 15-year, and 10-year terms are also typically available. And many lenders offer even more flexible terms, ranging from eight years to 40 years.
Originating in the 1930s, the 30-year fixed-rate mortgage remains America’s go-to loan for home purchases. In fact, about nine in 10 homebuyers opt for a 30-year fixed-rate mortgage, according to Freddie Mac.
How fixed-rate mortgages work
The prevailing mortgage rates advertised by lenders are always changing. You might see an offer for a 7.5 percent interest rate today and a 7.75 percent interest rate tomorrow. However, with a fixed-rate mortgage, once you lock in your rate and close on your home, your rate stays the same, no matter what happens in the broader market.
While a fixed-rate mortgage’s monthly payment amount is consistent, the portion of your payment that goes toward your principal versus your interest charges based on the loan’s amortization schedule. At first, most of your payment goes toward interest, and later in your loan term, more and more goes to the principal.
Fixed-rate mortgage example
Jill takes out a $300,000, 30-year fixed-rate mortgage at seven percent interest. Her monthly payment, excluding insurance and taxes, would be $1,996 for the entire 30 years.
In the first month, only about $245 of her payment reduces the actual loan amount, or principal, while the rest covers interest. Twenty years later, $987, or nearly half, of her payment goes toward the principal. By her last loan payment, only about $10 of her payment covers interest.
Current fixed-rate mortgage rates
Mortgage rates fell to historically low levels during the COVID pandemic, bottoming out at an average of 2.65 percent in January 2021. However, after the Federal Reserve began raising rates in March 2022, mortgage rates generally followed suit. After increasing to an average of 7.79 percent in October 2023, mortgage rates have remained above six percent — and often above seven percent — ever since.
Keep in mind that the mortgage rate analysts are typically discussing is the 30-year fixed mortgage rate. While 15-year fixed mortgage rates respond to all the same market forces, they’re often somewhat lower than the rates for 30-year mortgages.
Fixed-rate mortgage requirements
There are many types of fixed-rate mortgages with different borrower requirements. However, if you’re applying for a conventional mortgage — the most common type — you’ll likely need a credit score of at least 620 and a down payment of at least three percent.
Types of fixed-rate mortgages
If you’re interested in a fixed-rate mortgage, you still have some choices to make. Here are some types of mortgages you may want to consider:
- Conventional: Conventional fixed-rate mortgages usually have stricter requirements than government-backed loans, such as a minimum 620 credit score and a debt-to-income ratio no higher than 43 percent, with some exceptions. These loans are offered by banks, credit unions, online lenders, savings and loans associations, and mortgage companies.
- Government-backed: FHA loans, VA loans and USDA loans are all insured or guaranteed by a federal agency, which reimburses the lender if the borrower defaults. FHA loans have lower credit score requirements than conventional loans, while USDA loans are designed for low- and moderate-income borrowers in rural areas. VA loans are for qualified military service members, veterans, and surviving spouses.
- Conforming: Conforming loans adhere to Federal Housing Finance Agency (FHFA) requirements, including loan limits, allowing them to be sold on the secondary market.
- Non-conforming: Non-conforming loans, including jumbo loans, don’t meet certain FHFA requirements. To qualify, you might pay a higher interest rate and need to meet more stringent qualifications related to your credit score and cash reserves.
- Amortizing: The majority of fixed-rate mortgages are amortizing loans. This means that your monthly payments pay off both your principal and interest.
- Non-amortizing: Less common, non-amortizing loans offer lower monthly payments that may cover only the interest for a set period. When the interest-only period ends, there’s often a balloon payment, a large lump sum that covers all or most of the principal.
30-year vs. 15-year fixed-rate mortgages
Along with the different types of fixed-rate mortgages, there are also different term lengths. The most common are:
- 30-year fixed-rate mortgage: This is the most common mortgage term, allowing you minimize your monthly payment, though you will likely pay a higher interest rate.
- 15-year fixed-rate mortgage: These mortgages typically have lower interest rates than 30-year mortgages, but they require a much higher monthly payment. If you can afford it, though, you’ll pay much less in total interest than you would with a 30-year loan.
Lenders often also offer more customized terms, which may stretch longer than the standard 30 years — though this will also increase your total interest payments.
The term on a fixed-rate mortgage is the maximum amount of time you have to repay it, but you can also shorten your payback period by contributing additional money toward the principal. Just make sure your loan doesn’t have a prepayment penalty — most don’t — and that the extra payments are actually going toward the principal.
Fixed-rate mortgages vs. adjustable-rate mortgages
Though the most popular among Americans by far, fixed-rate mortgages aren’t the only loan in town. You can also choose an adjustable-rate mortgage (ARM), which is a loan with an interest rate that may increase or decrease over time, depending on prevailing market rates. Although the rate on an ARM can only change so often — typically every year or six months — and can only change so much each adjustment and over the life of the loan, they still make budgeting more difficult. ARMs are ideal for buyers who plan to stay in their new home only for a few years.
Pros and cons of a fixed-rate mortgage
Before you choose a fixed-rate mortgage, consider the pros and cons.
Pro of a fixed-rate mortgage
- Stable payments: Although your homeowners insurance and property tax payments might fluctuate, your mortgage payments stay the same, making it easier to budget each month.
Cons of a fixed-rate mortgage
- Higher interest rates: Lenders charge more for fixed-rate mortgages because they can’t adjust the interest when rates rise. Consequently, the monthly payments for fixed-rate mortgages tend to be higher, at least in the beginning, compared to those of adjustable-rate mortgages.
- No immediate rate reduction: If interest rates fall, you won’t benefit unless you refinance, a process that requires time and money.
What homebuyers should know about fixed-rate mortgages today
Although mortgage rates are higher now than they have been in the recent past, fixed-rate mortgages are still the best choice for many homebuyers, particularly if you’re looking for your forever home. In most cases, predictable payments trump the possibility of lower payments in the future — especially because rates could increase instead.
However, if you are planning to move within a few years, an ARM may be right for you. ARMs typically offer a lower initial rate for a period of time before the first adjustment. If you plan to move before your rate changes, you could save quite a bit on interest over a fixed-rate loan.
