Fixed-rate Mortgages: Element, Types, and How Does It Work

A fixed-rate mortgage is when the loan is issued with a pre-determined rate of interest that does not change for the entire terms of the loan.

The terms of this loan may be around from 10 years to 30 years. These types of loans are used by several consumers as it gives them peace of mind regarding interest expense they have to pay each month.

How does it work?

In the market, there are several types of mortgage products. Some of these are loans carry a variable rate of interest, and some of the loans carry a fixed rate of interest, and some are hybrid or adjustable-rate mortgages.

For the variable rate of interest, the exchange rate changes in line with the changes in the market. These changes might be the results of the monetary policy of the Government or any other changes in the economy.

In the variable rate of the interest, the pricing (interest rate) is set in such a way that spread is added in the benchmark/base rate.

Suppose the base rate changes the interest expense changes. It might not be a desirable mortgage for the borrower as they are uncertain about the rate of interest.

On the other hand, the fixed-rate mortgage does not fluctuate with external environmental conditions. So, the fixed-rate mortgage is more predictable in nature, and there are no such surprises for an increase in the rate of interest.

However, if the terms of the loan are higher, the interest expense I higher as well and vice versa. Similarly, in the initial years of the loan, the greater proportion of the installment is allocated to the interest expenses and less to the principal repayment.

See also  Paid-In Capital: Definition, Advantages, and Disadvantages

However, in subsequent years the proportion of the interest expenses keeps decreasing, and principal repayment keeps increasing as outstanding balance decreases resulting in lower interest expense.

key elements of Fixed-Rate Mortgage

  1. The rate of the interest is fixed and does not change with the fluctuation in the market rate of the interest.
  2. Borrowers who want certainty and long-term property tend to pick fixed-rate mortgages. So, they can plan for the budget with certainty.
  3. A house loan having a fixed interest rate for the whole period of the loan is a fixed-rate mortgage
  4. These loans are usually available for 30 years and 15 years of a mortgage. However, 5/1 adjustable loans have a fixed rate of interest for the first five years.
  5. These loans are available within different financial institutions that include banks, lenders of the mortgage, the Federal Housing Administration, and Veterans affairs.

How to Get a Fixed-Rate Mortgage

The fixed-rate mortgage can be applied in the banks and other financial institutions discussed above. However, it’s important to compare the interest rates offered by different lenders of the loans.

To make the research on the interest rate, the Consumer Financial Protection Bureau provides an excellent tool to compare the rate of interest for the different facilities available.

The tool helps to compare the fee for the loan, closing charges and to assess if there is a need for mortgage insurance.

Which type of mortgage is better?

There is no absolute answer to this question. The suitability of the mortgage type depends on several factors. Some of the factors are discussed below.

Predict the movement of the interest rate     

It’s important to predict the rate of interest for making a decision about opting fixed-rate mortgage or an adjustable-rate mortgage. If you expect the interest rate to increase in the future, opting for the fixed interest rate seems to be suitable.

See also  What is Cryptocurrency Exchange Traded Funds, and How do they Work?

On the other hand, if you expect the interest rate is expected to decrease, the floating rate/variable rate seems to be suitable.

Look for the loans for Federal Housing Authority

Look if you qualify for the loan from Federal Housing Authority – FHA. They can help you with the reduction of the closing cost and down payment for the loan. However, you need to qualify for FHA loans.

Determine appropriate terms of the loan

Closely analyze your financial condition to assess the extent of the installment affordability. If you can afford the balance repayment with the higher amount, the interest expense will be lower and vice versa.  

Find the best rate of the interest

Different financial institutions offer different terms of the loan. Some research may help to find the option with better terms of the loan.

For instance, the tool by Consumer Financial Protection Bureau – CFPB may help to compare different loan facilities available in the market.

Advantages of a fixed-rate mortgage

The fixed-rate mortgage has certain advantages and limitations as well. Some of these are discussed below.

  1. There is peace of mind that the rate of interest does not change, and the household budget can be planned easily. In other words, the interest rate risk is limited with fixed-rate mortgages.
  2. Increasing inflation might expose the variable rate of the mortgage with the spikes in the interest rate, especially in times of inflation.
  3. In addition to this, it also helps in prediction for the tax and other expenses.
  4.  The amortization schedule can be easily prepared with this type of loan and does not significantly change from lender to lender.
  5. They are ideal for the borrower looking for investment properties as they might plan to pay the interest with the income derived from tenancy. So, they don’t need to worry about fluctuation in the rate of interest.             
See also  Bond Vs. Debentures - 6 Key Differences

Disadvantages of a fixed-rate mortgage

  1. Sometimes, the fixed-rate mortgage may be expensive than the variable rate of interest, especially in a case when the interest rates fall in the future.
  2. The closing charges of the loan may be higher for a fixed-rate mortgage.
  3. It may be difficult to qualify for the fixed-rate mortgage because banks presume the risk of an increase in the interest rate. In other words, the banks may lose money if the rate of interest increase in the future.
  4. In fixed-rate mortgages, the proportion of the payments for the interest rate is higher. Hence, it may not be beneficial if you plan to sell the house with 10 to 15 years of the purchase.
  5. The fee for the arrangement of the fixed-rate mortgage may be higher than the variable rate of the interest. It may be a wise decision to bear the cost of the terms of the loan are longer and the interest rate is expected to rise in the near future.
  6. Usually, early repayment charges are higher for the fixed-rate mortgage. It may be expensive to negotiate restructuring or even some minor changes.