What Is A Fixed-Rate Mortgage, And How Does It Work?
One of the advantages of buying a home is the stability it offers. The home belongs to you, which means you don’t need permission to repaint the interior, adopt a pet, or have friends over. It also offers financial stability, as exemplified by the fixed-rate mortgage. While the initial interest rates on an adjustable-rate mortgage may be lower, a fixed-rate mortgage guarantees that your monthly loan payment remains the same from the first payment to the last.
Key Takeaways:
- A fixed-rate mortgage has an interest rate that remains the same throughout the repayment period, making it far more popular than an adjustable-rate mortgage.
- Fixed rates are available for most mortgage types, including conventional, jumbo, FHA, VA and USDA loans.
- Refinancing to a fixed-rate loan can save you money by lowering your interest rate, eliminating the need for mortgage insurance, or allowing you to borrow your equity.
Fixed-Rate Mortgages Explained
A fixed-rate mortgage is a home loan with an interest rate that stays the same throughout the life of the loan. When you close on a fixed-rate loan, the interest rate will remain the same the entire time you’re paying off your mortgage.
A steady interest rate means your monthly payment will stay the same from month to month. That’s a major factor in the popularity of fixed-rate loans, which constitute 92% of mortgages in the United States.
If you’re unsure of what type of mortgage you have, odds are it’s a fixed-rate mortgage.
Fixed-Rate Mortgage Vs. Adjustable-Rate Mortgage
The alternative to a fixed-rate mortgage is an adjustable-rate mortgage with an interest rate that changes based on market conditions.
Most ARMs have a fixed rate for a set introductory period, after which the interest rate adjusts at specific intervals. The introductory rate on ARMs often is lower than the rate lenders offer on a fixed-rate loan. You’ll usually see ARMs described as 5/1, 7/1 or 10/1, where the first number refers to the length of the fixed-rate introductory term and the second the adjustment interval. So a 5/1 ARM would have a fixed rate for five years and then would adjust once a year after that.
If market interest rates increase, an ARM’s interest rate and the monthly payment also will increase. The good news is most ARMs have limits on how much the interest rate can increase in any one interval and a cap on how high the rate can go overall. And if market rates decrease, so will your loan’s rate and monthly payment.
Fixed-rate mortgages are more predictable. The rate you receive when you close your loan will stay the same until you refinance, pay off the loan, or sell your home.
Some buyers choose an ARM to take advantage of the lower introductory rate, especially if they plan to refinance or sell the home before the rate begins to adjust.
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How A Fixed-Rate Mortgage Works
The two primary components of a fixed-rate mortgage are the interest rate and the loan term.
Interest Rate
The interest rate of a mortgage determines how much interest you’ll pay on the loan. The higher the interest rate, the more interest you’ll pay both monthly and over the life of the loan.
How Interest Rates Affect The Payment On A $400,000, Fixed-Rate, 30-Year Loan
| Interest Rate | Monthly Payment | Total Interest Paid |
|---|---|---|
| 5% | $2,147 | $373,023 |
| 6% | $2,398 | $463,353 |
| 7% | $2,661 | $558,036 |
| 8% | $2,935 | $656,621 |
Nationally, mortgage rates are determined by fluctuations in the bond market and the Federal Reserve. The interest rate a lender will offer you is further affected by your credit score, debt-to-income ratio and overall finances.
Fixed-rate mortgages are fully amortizing, meaning all the interest and principal are paid off over the loan term. Amortization also determines how much of each payment goes toward interest and principal. At the start of the repayment schedule, most of your payment will go toward interest, but the amount that goes toward the principal will increase until the loan is paid off with the final payment.
Loan Term
Your loan term is how long you are scheduled to repay the loan. Most loans have 15- or 30-year terms, but other options exist. A shorter term will have a higher monthly payment, but you’ll pay it off more quickly and pay less interest overall. A longer term will result in a lower monthly payment but will cost you more in the long run.
In the example below, you pay twice as much overall interest with a 30-year term than you would paying $934 a month more with a 15-year term.
Monthly Payment And Total Interest Paid On A $400,000 Mortgage At 7% Interest Based On Term Length
| Term | Monthly Payment | Total Interest Paid |
|---|---|---|
| 15 Years | $3,595 | $247,156 |
| 20 Years | $3,101 | $344,287 |
| 30 Years | $2,661 | $558,036 |
If you know the potential details of your fixed-rate mortgage, you can use our mortgage calculator to calculate your monthly payment.
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Types Of Fixed-Rate Mortgages
Many types of loans offer fixed rates. Here are the loans you can consider as you’re researching your options:
Conforming Conventional Loans
A conforming conventional loan is not backed by the U.S. government but does comply with federal rules that set a maximum loan amount, minimum credit score and minimum down payment. Lenders can sell loans that meet those rules to Fannie Mae and Freddie Mac, which reduces their risk. Conventional loans require borrowers who make a down payment of less than 20% of the purchase price to pay for private mortgage insurance until they have at least 20% equity.
Jumbo Loans
A jumbo loan exceeds the maximum loan limits set for conforming conventional loans. The 2024 limits are $766,550 in areas with an average cost of living and $1,149,825 for areas with a high cost of living. That means lenders cannot sell them to Fannie or Freddie and, therefore, take all the risk in making the loan. Jumbo loans often are more expensive than conventional loans and may have stricter eligibility requirements.
FHA Loans
Loans insured by the Federal Housing Administration are designed to help people with lower credit scores and less savings for a down payment buy a home. FHA loans require borrowers to have a credit score of at least 500 if they’re making a down payment of at least 10% of the purchase price. If they have a credit score of at least 580, they can make a down payment of 3.5%. FHA loans require borrowers to pay for mortgage insurance, an additional cost that can drive up your monthly payment.
VA Loans
Veterans Affairs loans are available only to active-duty military service members, veterans and their qualified spouses. They’re often easier to qualify for than other loan types, have no down payment requirement, and have low closing costs.
USDA Loans
USDA loans are specialized mortgages for buying homes in eligible rural areas. They’re targeted at low- to moderate-income buyers and have no minimum down payment requirement.
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When Should You Refinance To A Conventional Fixed-Rate Mortgage?
If you already have a loan and are thinking about refinancing, it may make sense to refinance to a fixed-rate loan.
From A Fixed-Rate Mortgage
The most common reasons to refinance a fixed-rate mortgage into a new one are to save money with a lower interest rate or to borrow your home equity with a cash-out refinance.
While the interest rate of a fixed-rate loan is set for the life of the loan, market rates rise and fall over time. If rates have dropped since you bought your home, refinancing to a new fixed-rate mortgage may save you money on interest and reduce your monthly payment.
If your home has increased in value and you can refinance with more than 20% equity, getting a new loan can eliminate the need to pay for PMI.
“The general idea is to refinance when you can secure a lower interest rate on the mortgage and, therefore, save money,” says R.J. Weiss, a Certified Financial Planner based in Geneva, Illinois.
Realizing those savings, however, takes time. “It’s not as simple as changing from a 7.5% mortgage to a 6% mortgage and immediately gaining savings,” Weiss says. “There are closing costs associated with obtaining a new mortgage. The goal is to reach your break-even point as soon as possible. This is the number of months it takes for your monthly payment savings to outweigh the closing costs.”
The longer you plan to own your home and the greater the decrease in the interest rate you can secure, the more it makes sense to refinance.
A cash-out refinance may be a good option if you need to pay for a major expense, such as home renovations, debt consolidation, education expenses or medical bills. You can take out a new fixed-rate mortgage based on your home’s current fair market value, pay off your current loan, and keep the difference as cash. You repay the borrowed money as part of your new mortgage payment.
From An ARM
Refinancing from an ARM to a fixed-rate mortgage gives you more certainty by locking your interest rate. That means you don’t have to worry about rising rates increasing your monthly payment. It’s especially common to consider refinancing to a fixed-rate loan if your ARM’s introductory period is about to end and your rate looks likely to increase.
From A Government-Backed Loan
Some government-backed loans have restrictions on how you can use your home or may have additional costs that you have to pay. For example, FHA loans require that you pay mortgage insurance premiums.
Refinancing to a conventional loan, especially if you’ve built up sufficient equity, can get you out of paying for mortgage insurance, saving you money in the long run.
Pros And Cons Of A Fixed-Rate Mortgage
Let’s look at some advantages and disadvantages of a fixed-rate mortgage.
Pros
- You have a consistent interest rate for the life of the loan.
- Having the same monthly payment makes budgeting easier.
- Your loan will fully amortize over its term.
- You can pay extra on your payment to pay down the principal, pay off the mortgage quicker and save on interest.
Cons
- Your interest rate may be higher than the introductory rate of an ARM.
- If market rates decrease lower than your fixed rate, you have to refinance to get the lower rate.
- An ARM may be better if you plan on selling or refinancing within five years.
The Bottom Line
Fixed-rate mortgages are popular because they ensure buyers’ interest rates and loan payments never increase. They’re also available with most loan types, whether conventional or government-backed. Drawbacks include the need to refinance if interest rates drop and rates that are typically higher than the introductory rate for ARMs.
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Victoria Araj contributed to the reporting of this article.
