Fixed Rate Mortgages: A Guide The bank rate
What is a fixed rate home loan?
A fixed rate mortgage has an interest rate that stays the same for the life of the loan. Fixed rate mortgages are the most popular type of financing because they provide predictability and stability. (Your total monthly payment, which includes home insurance and property taxes, may fluctuate slightly due to changing costs.)
How Fixed Rate Mortgages Work
The rates advertised by mortgage lenders are constantly rising and falling due to a wide variety of factors. So, you might see an offer for an interest rate of 3.2% today and an interest rate of 3.3% tomorrow. With a fixed rate mortgage, this movement does not impact you. No matter what happens after you get your loan, the rate stays the same.
Your payment amount also stays the same, but the breakdown of where those funds go – how much pays principal versus how much pays interest charges – varies depending on the amortization schedule.
Let’s say you put down a 20% down payment on a $ 200,000 home and borrow $ 160,000 with a 30-year fixed rate mortgage at 3% interest. You would have a payment of $ 674 each month, excluding insurance and taxes, for the next 30 years.
In the first month of your term, only $ 274 of your payment would go towards actual principal, with the rest going to interest. Twenty years later, over $ 500 of your payment would go towards principal. As the balance of these payments tilts more toward your principal, you accelerate the equity in the property.
How long do I have to pay off a fixed rate home loan?
You will pay off your fixed rate mortgage over a predetermined period of time. The most common offer is a 30-year fixed rate mortgage, which allows you to pay off your mortgage over three decades. It may seem like a long time, but the extended deadline allows you to reduce your monthly payment amount and free up space in your budget.
Another widely available option is a 15 year fixed rate mortgage. This usually comes with a lower interest rate, but you’ll have to pay off the loan in half the time. A 15-year fixed rate mortgage is ideal for borrowers who have cash on hand and want to pay off their home faster and at lower interest.
Some mortgage lenders also allow you to customize the term, between eight and 30 years.
While the term attached to a fixed rate mortgage is the maximum amount of time you have to pay it off, you can also choose to contribute additional money to the principal to shorten your repayment period. Just make sure your loan doesn’t have a prepayment penalty (most don’t) and that the extra payments pay off the principal. You can contact your lender to confirm this.
How to calculate fixed rate mortgage payments
Calculating your fixed rate mortgage payment requires a little math. You can use Bankrate’s mortgage calculator to get an idea of how much you’ll pay each month.
When determining the approximate amount of home you can afford, don’t forget to factor in the additional costs of owning a home, such as property taxes, home insurance, HOA fees, etc. maintenance and repairs.
Types of fixed rate mortgages
The number of years attached to a fixed rate mortgage is not the only point of distinction to consider. Here’s a look at the verbiage you’ll see next to fixed rate loans:
- Conventional – Conventional fixed rate mortgages usually come with slightly more stringent requirements to be approved, such as a minimum credit score of 620 and a debt-to-income ratio (DTI) of no more than 43%, although there are some exceptions to these rules. These loans are issued by banks, credit unions, online lenders, and other types of institutions.
- FHA, Virginia, USDA – FHA loans, VA loans, and USDA loans have fixed rates and come with less stringent requirements than conventional loans. FHA loans are the most widely available, while USDA loans are intended for certain borrowers in rural areas. VA loans are only available to eligible military service members, veterans, and family members.
- Compliant – A conforming loan adheres (“conforms”) to Federal Housing Finance Agency (FHFA) requirements, such as the loan limit, which allow it to be sold in the secondary market. As long as a loan meets these standards, it can be bought and sold to help move money through the mortgage market.
- Improper – Non-conforming loans, including jumbo loans, do not meet the requirements of the FHFA. To qualify, you may be paying a higher rate and having to verify some more stringent credit rating and cash reserve requirements.
- Amortization – The vast majority of fixed rate mortgages are amortizing loans, which means that your monthly payments are used for both principal and interest. From the first day you start paying off an amortizing loan, you build up equity in the home.
- Not depreciable – Non-amortizing loans are much less common, but have an interesting advantage: significantly lower monthly payments that may only cover interest for a certain period of time. However, when this benefit expires, you might be faced with a rude awakening with a lump sum payment.
Example of a fixed rate mortgage
Meet Jill, a first time homebuyer who wants to stop renting. She has calculated the numbers and knows that she can afford about $ 1,000 a month for the mortgage principal and interest charges.
By working back from that monthly payment, we can get an idea of how much Jill could borrow between two different fixed rate mortgages. (Note: We did not assume a down payment or closing costs in this scenario.)
|Rising||Fixed rate||Term||Monthly payment|
|$ 240,000||3%||30 years||$ 1,012|
|$ 152,000||2.5%||15 years old||$ 1,014|
For virtually the same monthly payment, Jill can borrow an additional $ 88,000 with a 30-year fixed loan.
Now let’s say Jill’s budget and strong credit allows her to opt for the $ 240,000 loan regardless of the loan term. If she chooses a 30-year fixed rate mortgage, she will pay a higher interest rate but take advantage of the option of extending the repayment period. This longer-term convenience comes with a major drawback, however – a much higher price tag for the overall interest charges:
|Rising||Fixed rate||Term||Total interest|
|$ 240,000||3%||30 years||$ 124,266|
|$ 240,000||2.5%||15 years old||$ 48,053|
If Jill can afford the higher monthly payments on a 15-year mortgage, she will save $ 76,213 in interest.
Fixed rate mortgages vs adjustable rate mortgages
When you compare fixed rate mortgages, you may also come across variable rate mortgages (ARMs). True to its name, an ARM’s rate adjusts as the market changes, but the loan comes with an introductory rate for a period of time.
For example, an ARM 5/1 has an introductory rate of five years. After this five-year period, your rate will change once a year. How the rate moves (up or down) depends on the index to which it is linked. Rate increases could be capped at 2% per annum, for example, and 5% for the life of the loan.
ARMs are more complex loans, and they are generally more beneficial for a borrower who does not intend to live in the home for a long time.
Compare mortgage rates
According to Bankrate’s latest national survey of lenders, the average 30-year fixed mortgage APR is 3.310%, while the average 15-year fixed mortgage APR is 2.650%. In comparison, the average 5/1 ARM APR is 3.910%.