A fixed-rate mortgage (FRM), also known as a “fixed-interest mortgage,” has a predetermined interest rate that stays the same throughout the life of the loan. Because the interest rate doesn’t change, the periodic mortgage payments don’t change either. Fixed mortgages are popular because they offer borrowers the stability of an unchanging monthly payment amount.
Fixed mortgages are appealing because they protect borrowers against inflation and rising interest rates. On the other hand, if interest rates fall, your mortgage rate will not (unless you refinance your loan). The predictability of a fixed mortgage can help you manage your budget and set long-term goals, since you basically know what your monthly mortgage expenses will be for the next 15 to 30 years.
On a fixed mortgage, a portion of each monthly payment goes towards interest (the lender’s charge for borrowing money) and the rest goes towards principal (the original loan balance). In the early years, the majority your mortgage payment is applied to the interest you owe ― but over time, the portion that goes towards principal will increase. This method of repayment is called “amortization.”
In general, the shorter the loan term is, the lower the interest rate will be. The two most popular types of fixed mortgages are the 15-year and the 30-year (although some lenders may offer shorter or longer terms). Be sure to ask if the mortgage loan comes with a “prepayment penalty” clause, which means the mortgage lender will charge extra fees if you pay off the loan balance sooner than originally agreed.
15-Year Fixed-Rate Mortgage
A 15-year fixed mortgage will have a lower interest rate (than a 30-year loan) because the lender is taking a lower risk on long-term inflation. The lower mortgage rate will reduce your total interest payments (saving money in the end) and increase your principal payments, which helps you build home equity faster. The shorter loan term means you’ll own the home sooner and at a lower cost.
While a 15-year fixed mortgage will save you money on interest, it comes with higher monthly payments (because you’re repaying the loan balance in less time). It may also restrict you to a less expensive home than you could afford with a longer loan term. As of April 15, 2010, the average U.S. mortgage rate for a conventional 15-year fixed mortgage was 4.40% (source: Freddie Mac Primary Mortgage Market Survey®).
30-Year Fixed-Rate Mortgage
A 30-year fixed mortgage allows a homebuyer to borrow money on a long-term basis. It will have lower monthly payments and a higher interest rate (which leads to a higher interest bill in the end) compared to the 15-year fixed mortgage. While a higher interest rate is less desirable, remember that mortgage interest can be deducted from your federal taxes.
The 30-year term helps create manageable mortgage payments, thus freeing up money for other investments or possibly allowing you to buy a more expensive house. But taking longer to repay your loan balance means you are building home equity at a very slow pace, which can become a burden in the future. As of April 15, 2010, the average U.S. mortgage rate for a conventional 30-year fixed mortgage was 5.07% (source: Freddie Mac Primary Mortgage Market Survey®).
Convertible Fixed-Rate Mortgage
Also known as a Reduction Option Loan (ROL), Reducing Interest Loan (RIL), or Reducing Interest Mortgage (RIM), this type of fixed mortgage comes with a rate-reduction option. Under certain circumstances, and for a moderate fee, this loan can be re-set (or “converted”) to a new interest rate based on the current market rate for fixed mortgages. The conversion fee is typically $100-$250, plus 0.25% to 0.40% of the original loan balance ― which is much less expensive than refinancing the loan (which could cost up to 5% or 6% of the loan amount).
The most appealing aspect of a fixed-rate mortgage is its predictability. Fixed mortgages are usually best for people with steady incomes who plan on staying in their home for at least 7 to 10 years.