Fixed-rate mortgages: How they work and their benefits

Before deciding which type of mortgage is right for you, you’ll need to be familiar with your options. Fixed-rate mortgages are popular with home buyers for their mostly predictable monthly payments but aren’t ideal for every borrower and every situation.

Learn the basics of fixed-rate mortgages and how they work to determine whether a fixed-rate loan is the best source of home financing for you.

What is a fixed-rate mortgage?

A fixed-rate mortgage is a home loan option that offers a single interest rate for the entire length of a loan. The interest rate on the mortgage never changes over the loan’s lifespan, potentially keeping the borrower’s mortgage payments the same month to month.

Changes in the market won’t impact your rate, making fixed-rate loans popular mortgages among borrowers.

How does a fixed-rate mortgage work?

Borrowers who take out a fixed-rate mortgage will lock in their interest rate at the beginning of the mortgage process. Once the borrower is approved for the mortgage loan, this interest rate will remain the same for the entire loan repayment term. That means you’ll pay the same amount for every monthly mortgage payment – barring any changes in your property taxes or homeowners insurance, which are both usually included in mortgage payments along with mortgage principal and interest.

Your lender holds your property tax and homeowners insurance payments in an escrow account and pays them for you when they’re due. The amount you’ll pay in both property taxes and homeowners insurance is outside of your lender’s control, however.

Understanding a fixed-rate mortgage payment

Most fixed-rate mortgages are amortizing loans, meaning your monthly payments will cover both your principal and interest. In the first few years of making mortgage payments, the majority of each payment will go toward paying off interest rather than the principal balance (the total loan amount).

Let’s say you have a 30-year fixed-rate mortgage and your monthly payment is $1,500. When you begin paying off your mortgage, $1,400 of the $1,500 payment may go toward interest with just $100 going toward the principal. But as you progress through the life of your loan, the payment allocation gradually shifts. At some point, you may pay an equal amount in interest and principal.

By the end of the loan’s amortization schedule, you’ll pay significantly more principal than interest. You might even end up putting $1,400 toward the principal and $100 toward interest – a complete reversal of how you started.

How are fixed-rate mortgages different from adjustable-rate mortgages?

Another mortgage option that affects your interest rate is an adjustable-rate mortgage, or ARM. With an ARM, you’ll likely pay a lower interest rate during the introductory period, which can vary in length from one ARM to another. After the fixed-rate introductory period, the rate on an ARM can adjust up or down based on market conditions.

Whether you should go with a fixed-rate mortgage or an ARM will depend on several factors. Know these facts about ARMs before making your decision:

• ARMs are risky. The big risk with an ARM is that interest rates may go up. When that happens, you’ll pay more in interest every month if you’re past the introductory period (which typically lasts the first 5, 7 or 10 years of the loan). If mortgage rates are fairly low when you’re approved for the loan, you may be better off with a fixed-rate mortgage.
• ARMs are cheaper upfront. Fixed-rate mortgages typically have a slightly higher rate than ARMs starting out. However, once an ARM’s low introductory rate period ends, your rate may increase, causing your monthly payments to go up.
• ARMs can make sense for shorter home stays. An ARM’s low introductory rate can be very tempting, especially if you don’t plan on living in a home for a long time. If you plan on selling your house before the rate adjusts, you can save money with an ARM.

Pros and cons of fixed-rate mortgages

Fixed-rate home loans are popular for a lot of good reasons, but this mortgage option also has some downsides. The benefits and drawbacks of fixed-rate mortgages are both worth digging into.

Pros

• You’ll have more predictable monthly payments. The main benefit of a fixed-rate mortgage is that your monthly mortgage payment will remain the same throughout the life of the loan unless it changes because of an increase or decrease in what you owe in property taxes and/or homeowners insurance premiums.
• Your interest rate won’t change. Even if the housing market shifts and mortgage rates rise, your interest rate with a fixed-rate mortgage is locked in for the length of your loan repayment term.
• You can compare options more easily. If you’re shopping around for mortgage lenders, comparing your fixed-rate options will be easier than comparing adjustable-rate mortgages since not all adjustable-rate mortgages adjust at the same time.

Cons

• The interest rate will likely be higher with a fixed-rate loan. Fixed-rate mortgages typically have a higher rate than the introductory rate an adjustable-rate mortgage offers. You pay a higher rate and make a higher overall mortgage payment.
• Lenders may have stricter credit requirements. Generally, the credit requirement for a fixed-rate loan is more rigid than the credit profile needed to qualify for an ARM.
• Mortgage rates could go down. If you lock in a relatively high rate and then market interest rates come down, you’ll be stuck with your initial high rate for the life of the loan unless you refinance to a loan with a lower rate. Refinancing isn’t free, though, as you’ll have to pay closing costs just like you did with your original mortgage.

What are your fixed-rate mortgage options?

You can get most mortgage types, and with a loan repayment term of 30 or 15 years, if you meet their eligibility requirements. You’ll have options when shopping for a fixed-rate mortgage.

Conventional loans

A conventional mortgage, which by definition is a home loan not backed by the federal government but by a private lender, is the most common type of home loan. Requirements may include a minimum credit score of 620, a debt-to-income ratio (DTI) no higher than 36%, and a down payment that’s at least 3% of the purchase price.

Government loans

Federal Housing Administration (FHA) loans, Department of Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA) loans are all national loan programs backed by the federal government. In some cases, government-backed loans have more lenient requirements than conventional loans.

30-year fixed

A 30-year fixed-rate mortgage, whether in the form of a conventional loan or a government-backed loan, is the most popular financing option for borrowers. You can keep monthly payments lower by choosing this lengthy loan repayment term – even with a slightly higher interest rate. In most cases, you’ll have a higher interest rate the longer your repayment term.

15-year fixed

When you opt for a 15-year mortgage repayment term, you’ll save quite a bit of money on interest compared to a 30-year mortgage. A 15-year fixed-rate loan typically features a lower rate than a 30-year loan, and because the loan has an amortization period of 15 years versus 30, you’ll save even more on interest.

In fact, you’d enjoy an interest savings even if the 15-year loan and 30-year loan had the same rate. That savings is possible by simply choosing a shorter-term mortgage.

Is a fixed-rate loan right for you?

Fixed-rate mortgages are prized for their stability. If you want to put your monthly mortgage payments on autopilot or interest rates are low when you apply for a mortgage, a fixed-rate loan will probably make a lot of sense.

A 30-year mortgage is typically the most appropriate option for home buyers more concerned about minimizing monthly housing costs than the overall cost of the loan.

If you’re considering a 30-year mortgage repayment term, think about what’s more important to you: lower monthly payments or paying off your loan faster and paying less in interest over time. You can get help answering this question by using our mortgage calculator.

The bottom line: A fixed-rate mortgage is ideal if you prioritize predictability

A fixed-rate mortgage will give you more predictable monthly payments and a single interest rate for the life of the loan. Whether you save money with a fixed-rate loan versus an adjustable-rate mortgage will depend on multiple factors, including some beyond your control (think market rates and their influence on adjustable-rate mortgages).

Ultimately, you should choose a loan program based on your financial situation and what makes you financially comfortable.

Need financing for your new home? Get started today with Rocket Mortgage^®.