What is a fixed-rate mortgage and how does it work?
A fixed-rate mortgage has a fixed interest rate, meaning that the interest rate and thus the borrower's monthly payment will be consistent throughout the life of the loan. Although getting a fixed-interest rate mortgage is usually preferable due to their payment predictability, they do have some downsides that will be discussed in this article.
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Read on to learn more about characteristics of a fixed rate mortgage.
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How does a fixed-rate mortgage work?
Fixed rate mortgages are easy to apply for and are the most popular type of home financing. With a fixed-rate loan the interest rate is fixed for the entire loan term. As a result, the monthly payment will be the same for the life of the loan. Term options include 15-, 20-, and 30-year mortgages.
Types of fixed-rate mortgages
There are many types of fixed-rate mortgages available. Let’s look at each one in detail:
Conventional. These mortgages are loans that are not government sponsored. There are two types of conventional loans: conforming and non-conforming.
Conforming. According to the Consumer Financial Protection Bureau, Fannie Mae and Freddie Mac are government sponsored enterprises that guarantee most of the mortgages made in the U.S. Fannie Mae and Freddie Mac are restricted by law to purchasing single-family mortgages with origination balances below a specific amount, known as the “conforming loan limit” (CLL) value. Conforming mortgage loans conform to specific guidelines that allow these loans to be purchased by Fannie Mae and Freddie Mac.
Non-conforming. Loans above the CLL value do not conform to Fannie Mae and Freddie Mac guidelines and are known as jumbo loans. Other non-types of conforming loans are government-sponsored (also called government-backed loans). These include FHA, VA, and USDA loans.
Amortized loans. Amortization is a way that loans are paid off such that both the principal loan amount and interest are each paid from the total monthly loan payment. This steadily reduces the overall amount owed. At the end of the loan term an amortized loan will be paid off (if it is not refinanced along the way).
Non-amortized loans. Some loan types let the borrower pay more toward the principal loan amount only, while the loan interest continues to grow. Borrowers may choose this type of loan so they’ll have lower monthly payments; however, these loans result in “negative amortization.” This means that at the end of the loan term, the loan is not paid off and more money is owed in interest.
Advantages of fixed-rate mortgages:
- Interest rate never changes. The interest rate is fixed as long as you keep the loan
- Predictable payments. If you like predictability in your monthly payments, then a fixed-rate mortgage is for you.
- Better for long-term homeowners. If you plan to own your home for many years a fixed-rate loan gives you lower monthly payments because it’s spread out over more years.
Disadvantages of fixed-rate mortgages:
- Potentially higher rates than adjustable-rate loans. Lenders typically charge higher interest rates on fixed-rate mortgages.
- More expensive. The longer term means you’ll pay more interest over the life of the loan.
- Harder to qualify for. Because the rates are usually higher, qualifying can be harder due to the lending criteria, and you may not be able to afford as much house.
- Not as good for short-term owners. If you are buying a home to fix, renovate and sell (fix-and-flip), then an ARM can save you money in interest payments. You’ll have the property sold before the rate adjusts higher and, in the meantime, you’ll pay a lower interest rate.
- Can't take advantage of lower interest rates. Having a fixed-rate is great when interest rates go high and you benefit from a low-range rate. But if interest rates go very low, you miss out on that opportunity (unless you refinance to a lower rate).
How long are fixed-rate mortgages?
The length or duration of a loan is called the “term,” which describes the length of the repayment period. Fixed-rate mortgages are available in three common term lengths: 30-years, 20-year, and 15-years.
The principal and interest in your loan payment are calculated based on the loan’s term. If you refinance your mortgage during this time, you will get a new loan with a new term.
Fixed-rate mortgages vs. adjustable-rate mortgages: which is better?
Deciding between a fixed or adjustable interest rate is a personal financial decision that only you can make. The characteristics of a fixed-rate mortgage do make the payments predictable, which helps many homeowners with planning their monthly budget.
Before choosing a mortgage, consider these factors: your income, how long you plan to own the home, and your tolerance for risk. Your lender will be able to guide you through the basic pros and cons, but the rest is up to you.
To help you decide between a fixed-rate loan or adjustable-rate loan be sure to speak with a CU SoCal loan representative.
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How much mortgage can I afford?
There are several factors that determine how expensive of a house someone can afford, including credit score, income, debt-to-income ratio, down payment amount, and more.
When determining how much house/mortgage you can afford, lenders use the 28/36% rule, which we’ll discuss in this article. Learn more about
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Why savvy consumers choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including mortgages, Home Equity Loans, HELOCs, car loans, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
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