Fixed-rate mortgages – also called conventional mortgages – have been the most popular home loans for decades. The interest rate on a fixed-rate mortgage stays the same throughout the life of the loan, as opposed to adjustable rate mortgages (ARMs), in which the interest rate may adjust or “float.”
Fixed-rate mortgages allow for repayment of a debt in equal monthly mortgage payments over a specified period of time, called an amortization period. At the end of the amortization period, which can last anywhere from 10 to 50 years, the loan will be paid in full. Because a 30-year amortization period is the most common, the 30-year fixed-rate mortgage has become the industry standard in the United States.
For the first few years of a 30-year mortgage, most of your monthly payment goes toward interest, but toward the end of the loan period, much of your monthly payment goes toward principal.
What Determines 30-Year Fixed Mortgage Rates?
Interest rates on 30-year fixed mortgages are driven by 1-year, 5-year, and 10-year Treasury Note yields, which are auctioned to the highest bidder. At the end of the note’s term, the U.S. Government pays back full face value to the bidder, so in effect, bidders are loaning the bid amount to the U.S. Government. In return, they get the interest rate and the full face value on the note.
As a result, the interest rate on a 30-year fixed mortgage is usually just slightly higher than that of the 30-year Treasury Bond at the time the mortgage is issued. Thanks to low rates on Treasury Bonds, the interest rates on 30-year fixed-rate mortgages have been below 7 percent since March 2002, and have dropped even lower in 2009, averaging between 4 and 6 percent.
What are the Advantages of a 30-Year Fixed-Rate Mortgage?
Whether purchasing a new home or refinancing current property, most borrowers prefer 30-year fixed-rate mortgages over adjustable rate mortgages. The major selling point is that the fixed mortgage rates provide the security of knowing exactly how much they will pay for principal and interest each month. When choosing a fixed rate mortgage, you never have to worry about your payment unexpectedly increasing if interest rates rise. If interest rates drop, you can refinance the property by paying off your current mortgage and obtaining a new 30-year fixed mortgage at a lower interest rate.
Another advantage of 30-year fixed-rate mortgages is that borrowers have the option of making larger monthly payments and directing the additional portion of the payment toward principal, thereby decreasing the principal balance of the loan faster. For example, by paying half of your monthly mortgage every two weeks, you would pay off your mortgage in 22 years. And by making one extra principal payment per year, you would reduce the amortization period to about 26 years.
What are the Disadvantages of a 30-Year Fixed-Rate Mortgage?
Fixed-rate mortgages are usually more expensive than adjustable rate mortgages because the interest rate on long-term fixed-rate loans tends to be higher than the rate on short-term loans. Although some studies have shown that the majority of borrowers with adjustable rate mortgages save money in the long run, some borrowers pay more than those with fixed-rate mortgages when interest rates suddenly escalate. In other words, while you may save money initially on an adjustable rate loan, you risk losing money down the road if rates unexpectedly rise.
So, when deciding between the security of a 30-year fixed-rate loan or the potential cost savings and higher risk of an adjustable rate loan, it’s important to consider several factors, including the length of the loan term, the current interest rate, how long you plan to stay in the home, and the likelihood that the interest rate will increase or decrease during the life of the loan.
Should I Pay Points on My Mortgage?
You can lower your interest rate by paying “points” on your 30-year fixed loan. A point is worth 1 percent of your total loan. Each time you pay a point, you decrease your interest rate. To figure out how long it would take you to recover the cost of these points, subtract what your monthly payment would be if you were paying points from your current monthly payment. Then divide that number into your points to determine the number of months it will take to break even.
Deciding which kind of mortgage is right for you and your individual financial situation takes careful foresight and consideration. While adjustable rate mortgages may seem more appealing, it’s important to weigh the risks of unpredictable, fluctuating interest rates. For many, a 30-year fixed-rate mortgage provides the stability needed for smart financial planning.
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