What Is A Fixed-Rate Mortgage And How Does It Work?

If you are new to the home buying game, you’re probably astonished at the amount of lingo you’ve been hearing and reading about. You can have a fixed-rate or adjustable-rate mortgage. It can have a term of 15 or 30 years, or even a custom term. And so much more!

Turns out, you have to decide which type of mortgage is right for you. But before you can decide whether a fixed-rate mortgage makes sense for you, you need to know the basics about what these types of mortgages are and how they work.

A fixed-rate mortgage is a home loan option with a specific interest rate for the entire term of the loan. Essentially, the interest rate on the mortgage will not change over the lifetime of the loan and the borrower's interest and principal payments will remain the same each month.

With this type of mortgage, even fluctuations in the market will not have an impact on the rate. Because of this, these types of home loans are the most popular mortgages in the U.S.

When it comes to fixed-rate mortgages, the name says it all.

When you get one of these mortgages, your interest rate will remain the same for the entire time you’re paying off the loan. In other words, the interest rate is fixed.

Fixed-rate home loans are the backbone of the mortgage industry for a lot of good reasons.

Pro: Consistent Payments Make Budgeting Easy

The main benefit of a fixed-rate mortgage is that your monthly mortgage payment will remain the same throughout the life of the loan. With a fixed-rate mortgage, the amount you pay toward the mortgage itself, the part that’s made up of your principal and interest, won’t change.

There’s only one caveat: if your homeowners insurance premium or property taxes go up or down, your payments will change to reflect your new costs. Those factors are outside of your lender’s control, but your monthly mortgage payments will probably include these expenses. Your lender will hold those additional expenses in an escrow account and pay them for you when they come due. This makes your life easier and prevents a missed property tax or insurance payment that could become a huge headache.

Pro: Your Loan Fully Amortizes Over The Term Of The Mortgage

As you learn about fixed-rate mortgages, you’ll also hear the term amortization. Mortgage loans typically have a set length of time that dictates when they’ll be paid off. For example, you may have a 30-year fixed-rate mortgage, which means that after 30 years of monthly payments, your mortgage will be fully paid off. Because your rate is fixed, you’ll know exactly how much interest you will pay for the life of your loan. And because the mortgage term is 30 years, you enjoy a low payment relative to the amount of your original mortgage.

How Amortization Works: An Example

In the first few years of making mortgage payments, the majority of your payment will go toward paying off interest, rather than the principal (the original loan amount). For example, say you have a fixed-rate loan with a monthly payment of $800. When you first begin paying off your mortgage, you’ll pay the full $800, but $750 of it might go toward interest while only $50 goes toward the principal. But as you progress through the life of your loan, the balance changes. At one point, you may pay an equal amount in interest and principal. By the end of your loan’s amortization schedule, you’ll be paying mostly principal and very little in interest; for example, maybe you pay $750 toward the principal and only $50 in interest.

Con: You’ll Pay A Little More Initially

Fixed-rate mortgages will have higher rates than the introductory rate you’ll get on an ARM (discussed below). You’re paying a bit more in exchange for the peace of mind that you’ll have a low rate locked in for the entire time you’re paying off the loan.

A loan’s term refers to how long you’ll be paying it off. The most common loan terms for fixed-rate mortgages are 30 years and 15 years, each with their own pros and cons.

30-Year Fixed

30-year fixed-rate mortgages are the most popular option for borrowers. Because the loan term is long, you can keep your monthly payments nice and low, even with a slightly higher interest rate (although there are rare exceptions, the longer mortgage term you chose, the slightly higher rate you’ll get). Though borrowers can save money on interest by going with a short-term mortgage, 30-year loans often present the most affordable option for those who are more concerned about keeping their monthly housing costs down than the overall costs over the loan’s lifespan.

If you’re considering a 30-year mortgage term, think about what’s more important: lower monthly payments, or paying off your loan faster and paying less in interest over the life of the loan? You can check this using our mortgage calculator.

15-Year Fixed

When you opt for a 15-year mortgage term, you’ll save quite a bit of money on interest compared with a 30-year term. Not only do 15-year loans typically have lower rates than 30-year loans, but because the loan has a shorter amortization period, you’ll save even more on interest. This holds true even if you were to have the same interest rate on both a 15-year loan and a 30-year loan. Let’s look at an example of this.

30-Year Fixed Vs. 15-Year Fixed, By The Numbers

Say you get a mortgage for $200,000 with an interest rate of 4%. With a 30-year fixed-rate mortgage you’ll pay around $143,739 in interest over the life of the loan. Take the same situation but swap the 30-year for a 15-year loan. Over the course of a 15-year loan, the total interest paid will be around $66,288. This example assumes that both loans come with a 4% mortgage rate. The reality is that the 15-year loan will have a lower rate than the 30-year loan (because the length of the loan is shorter). So you would actually pay even less interest than we’ve shown in this example.

Seems like the 15-year is the obvious choice, right? Not so fast. Don’t forget to consider your monthly payment. On the 15-year loan, your monthly payment would be around $1,479, not including taxes and insurance, because there is a shorter term to pay the mortgage off. With the 30-year loan, your monthly payment would be a significantly more affordable $955.

If you can afford the larger payments and are most interested in building equity and paying off your home quickly, the 15-year may be a better choice. It just depends on what your finances can comfortably handle. If you aren’t sure, it’s always a good choice to choose the loan that allows you the most financial flexibility and make extra payments toward your principal.

Other Fixed-Rate Mortgage Terms

Depending on the lender, you may also find other fixed-rate loan terms that better fit your needs. Perhaps you’d like a loan that balances the affordability of a 30-year term with the interest-saving benefits of a 15-year loan. 20-year terms are a good example of this and are another popular option for borrowers, though not as commonly touted as the 15- or 30-year.

Here’s the best part. You can actually pick your own fixed-rate term that meets your financial goals. Rocket Mortgage offers fixed-rate mortgages with terms from 8 – 30 years.

The question of whether you should opt for a fixed-rate mortgage or an ARM depends on a few different factors.

With an ARM, you will likely pay a lower interest rate during an introductory period, which can vary in length. After the fixed-rate introductory period, your rate on an ARM can adjust up or down, depending on market conditions.

• ARMs come with risk. You are assuming a risk with an ARM that interest rates will go up, and if that happens, you’ll pay more in interest every month. If you are applying for a mortgage at a time when interest rates are high, you might be making a good bet. If mortgage rates are low, however, you're probably better off with a fixed-rate mortgage.

• ARMs are initially cheaper. Fixed-rate mortgages typically come with slightly higher rates than ARMs. However, once the lower introductory rate period on an ARM is over, your rate could increase, causing your monthly payments to go up. On the other hand, if rates go down when your ARM adjusts, you might end up saving even more with an ARM.

• ARMs might make sense if you don’t plan to stay in the home long. An ARM’s low introductory rate can be very attractive, especially if you don’t plan on remaining in your home for a long time. Typically, your introductory rate remains fixed for the first 5, 7 or 10 years you have the loan. If you know you’ll be selling your house before your rate adjusts, you can save money by opting for an ARM. Plus, if interest rates are currently relatively high, an ARM can help you get a lower rate.

As we’ve seen, fixed-rate mortgages are great for stability. If you don’t want to have to worry about your monthly payments changing down the road, a fixed-rate loan can make a lot of sense. They can also be a good choice if interest rates are low, as they are currently.

Ultimately, the type of mortgage you choose will depend on your own financial situation, and what you’re comfortable with. If you’re ready to get started with the mortgage process, you can begin your application online with Rocket Mortgage.