One of the most common types of mortgage loans is the fixed-rate loan. This term refers to the interest rate on the loan being set or the lifetime of the loan. As a home buyer, it’s important to know what all of your options are when it comes to selecting a loan. Looking at the interest rate and finding the lowest possible option is, by far, the best first step to take. Slight differences in these loans, even by a fraction of a percent, can indicate thousands of dollars of difference in what you will pay for your home.
What Is a Fixed Rate Mortgage Loan?
Fixed-rate mortgages are those that have an interest rate that stays the same from the start of the loan until the final payment is made. That means your monthly payment will remain the same throughout the lifetime of the loan.
By comparison, an adjustable-rate loan is one that has an interest rate that may change during the lifetime of the loan. These loans, also called ARMs, are designed to provide a low-interest rate, generally, at the start of the loan, that can increase over time. They may stay fixed for a period of a few months to years. After that point, the interest rate resets, often according to the current interest rates available in the industry. Most ARMs do not adjust downward, but they can stay the same if industry rates remain lower.
What Are the Advantages of a Fixed Rate Mortgage?
Fixed-rate mortgage loans tend to be the ideal choice for many people. They may make it easier for you to budget for your monthly payment month after month. This means you do not have to worry about your payment getting bigger down the road and becoming too expensive for you to maintain.
It’s important to know that your mortgage payment may still change somewhat. For example, if your mortgage payment includes tax payments or insurance policy payments, those costs can change, increasing your mortgage loan payment. However, you are not paying any more in terms of interest through a fixed-rate loan. That’s an important difference for most people.
The advantages of fixed-rate mortgages include being able to make consistent payments without the risk of adjustments. An ARM, on the other hand, may see the interest rate rise year-over-year, significantly increasing what you will pay. However, that may not be the case. In some situations, interest rates may remain very low, making these payments significantly lower than fixed-rate loans. The key is to know market conditions to know what is likely to happen.
Is a Fixed Rate Mortgage More Expensive Than an ARM?
You may see ARM interest rates that are very attractive, sometimes a full percentage point lower than what fixed-rate mortgages are. This may make them less expensive loans for their initial fixed-rate period before they begin to adjust. While they may be lower costing initially like this, most ARMs will increase in costs over time. For example, in 10 years, that interest rate may have climbed three or four times, making it more expensive than what you could expect with a fixed-rate loan.
The best way to know if a fixed-rate mortgage is right for you is to compare loan terms to each other. Ask your lender to create an amortization for a fixed-rate mortgage for the life of the loan. This will break down each monthly payment, including how much is going to premium payments and how much is going towards interest payments. It also gives you a total amount of interest you will pay on the loan.
Now, do the same for an ARM. The key here is that you don’t know how much interest rates will rise during the loan term. Your lender may be able to give you some indication of what’s expected or may be able to run tools that can offer various scenarios for you to consider. Look at the interest rate costs in both cases at the end of the loan. That’s the most important indicator of just how affordable one loan option is over others.
How Long Is a Fixed Rate Mortgage?
Like most other home loans, you can work with your lender to determine the length of a mortgage loan that is right for your situation. This will range for various reasons. To save the most money, you want to secure a loan that gives you:
- A monthly payment you can easily afford to make
- The shortest length of time you can repay your loan at that monthly payment
The most common option for a fixed-rate loan is a 30-year loan. Many of the FHA and VA loans are fixed-rate loans for 30 years. The benefit of choosing a fixed-rate mortgage in a 30-year loan is that the interest rate is going to stay very level throughout the lifetime of the loan. For the next 30 years, you have the same loan payment no matter what your goals are.
Another option is a 15-year loan. If you secure a fixed-rate loan for 15 years, you are likely to spend less in interest because there is less time for interest to build. In a fixed rate 15 year loan, you will continue to have the same loan payment from the start to the finish.
Thinking about a short term loan? For some people, staying in the loan long term isn’t the goal. They want to (and have the means to) repay the loan quickly. In the case of a fixed-rate loan, though, this can be limitedly beneficial. You may end up paying more in the long term.
Here’s an example.
Let’s say you decide to purchase a home with a 7-year fixed-rate mortgage. From the start to the end of that loan period, the interest rate remains the same. Your payments remain the same. However, you could also choose an ARM loan for 7 years. In this case, you may be able to secure an ARM with an interest rate that’s significantly lower than what you qualify for at a fixed rate. It has a fixed rate period for four years. That means the ARM will adjust a few times before you pay off the loan. If adjustments are capped (in terms of how much they can rise year after year), you may be able to pay less overall. The initial costs for an ARM may be less, and the increases upward over the remaining term may still be lower than what you would pay if this was a fixed-rate loan.
Which one is right for you? In this case, it is important to know what your goals are and what risks you have to not being able to pay off your loan right away. The shorter the term is, the less you will pay, but the shorter term also drives up the monthly payment, making it more expensive.
Can You Pay Off a Fixed Rate Loan Early?
The answer here is yes, in most cases. You will want to read the terms of your mortgage loan before doing so. However, most mortgage loans allow you to pay them off early, which can reduce the amount of time interest is present and growing on your loan, saving you a lot of money. There are two ways to consider this.
#1: Make Additional Payments
The most common option is to make additional payments to pay off what you owe. For example, you may want to pay a bit more each month with your payment. If this is the case, have that extra payment apply to the principle of your loan. That will reduce how much you pay in the long term to afford your home. You can also come into a lot of money and just pay off your loan at one time.
#2: Refinance It
Most fixed-rate loans allow you to refinance them as well. Refinancing a fixed-rate loan allows you to pay off the existing loan and secure a new one. Most loans allow you to do this at least after the first year.
Another way to consider refinancing is how it applies to ARM loans. Some people may wish to obtain an ARM loan to take advantage of the initially low-interest rate. Then, they may want to refinance the loan at the end of that term into a fixed-rate loan. Doing this may help you to keep costs low. However, there are limitations here. Some ARMs have restrictions on when you can refinance. In addition to this, you have to factor in the savings benefits that come from the process when you take into consideration closing costs. Again, work with your lender to learn more about each option.
How Should You Compare Fixed Rate Loans?
Fixed-rate loans are very common and available through most lenders. If you are thinking about securing this type of loan, work closely with your lender to find one that’s right for you. There are many options to consider. Here are some factors to keep in mind as you compare these loans.
FHA loans are a type of fixed-rate loan (most commonly). They have lower down payment requirements, lower interest rates, and better overall features. They may be more readily available to those who hare a moderate credit score. FHA loans, which are typically for first-time homeowners, may be available to you from your lender.
If you are a member of the U.S. Armed Services, either active duty, reserve, or retired, there may be options available to you through VA loans. Your lender can help you to determine if you qualify. VA loans have no down payment requirements. Interest rates tend to be lower (and fixed), and they are easier to qualify for overall.
Work with your lender to determine which loan term is best for you. It is always a good idea to aim for the shortest loan term possible that is still within your budget. Your lender may offer several options to you, depending on the amount you are borrowing for the loan, as well as other factors. The key here is to look at all of your options and the expected monthly payment before making a buying decision.
Most loans require a down payment, including most fixed-rate loans. This is the amount of cash you will pay at the time of purchasing your home. It’s best to make a down payment when possible (or required by the lender) as it reduces the amount of risk present, reducing interest rates. Down payments also help to reduce your costs in the long term because you are borrowing less to buy the home.
Type of Loan
You can find fixed-rate loans for most needs. This includes single-family homes, multi-family homes, open land, construction loans, and even home equity loans. Your lender may be able to help you find a loan that’s unique enough to offer you the flexibility you need not only for purchasing your home but also making upgrades or repairs to it at the time of your purchase.
Use a mortgage calculator or other tools to look at several loan options. Lenders may have several options for you to choose from, which is great until you are unsure which is right for your needs. Always look at the details of the loan, including the monthly payment, whether mortgage insurance is a requirement, and any associated fees.
Overall, fixed-rate mortgage loans are very common. To find out if they are right for you, apply for one, or request a quote from your lender. Then, start looking at the features and details of the loan to determine which is best for your situation. It may be the ideal way for you to secure the funds you need to buy your next property.