How a Fixed-Rate Mortgage Works

When you get a mortgage, there is much to consider. One of the biggest decisions a borrower will make is whether to choose a fixed-rate mortgage, or an adjustable-rate mortgage (ARM). While both loans have their benefits, you should begin your research by reviewing your budget and overall lifestyle to ultimately choose the perfect fit for you.

So, what exactly is a fixed-rate mortgage, and how does it work?

What is a Fixed-Rate Mortgage?

The definition of a fixed-rate mortgage is simply a mortgage with a set interest rate that does not change over the life of the loan. There’s a reason why fixed-rate mortgages are the most popular type of loan – it offers the borrower consistent monthly payments with no surprises. That predictability and stability can be pretty attractive for those who like to stick to a rigid budget.

How Does a Fixed-Rate Mortgage Work?

The mortgage term for fixed-rate mortgages typically come in terms of 15 to 30 years. The term refers to the length of time you will pay off the mortgage until it is paid in full. For example, a 30-year fixed rate mortgage would take 360 months of equal payments until you would own your home.

Many people like to stick to the 30-year term because the monthly payments are lower than a shorter-term mortgage. However, you will pay more in interest compared to a shorter term. The reverse effect will happen in a shorter loan term – higher monthly payments, but a lower amount paid towards interest.

If you do choose a longer term, you may be able to borrow more money and free up your monthly budget for other financial goals and emergencies. On the other hand, if you choose a short term and make your payments, you will own your home sooner and can cross the mortgage loan off of your monthly bills.

You can find out how much mortgage principal and interest you might pay for a home loan by using a mortgage calculator. A mortgage calculator will generate an amortization schedule, which can be a great tool to help you see what the true cost of your home may be and the exact amount you would pay each month.

More specifically, a fixed-rate mortgage calculator can compare monthly payments and interest costs of home mortgage scenarios at various term lengths to help you determine which length you can comfortably pay down.

Should You Get a Fixed-Rate Mortgage or an Adjustable-Rate Mortgage?

When evaluating a fixed-rate mortgage vs. an ARM, it’s important to assess your needs and pick the loan that best fits your situation. The difference between a fixed-rate mortgage and an ARM is that when you take out a loan with a fixed-rate mortgage, the interest rate will stay the same throughout the life of the loan. With an adjustable rate mortgage, the interest rate may fluctuate after the initial term based on market conditions.

Many ARMs begin with a stable lower interest rate. This initial rate could stay the same for months, a year, or even a few years, but once this initial period is over, your interest rate will be tied to an index. Essentially, your lender will adjust the interest rate based on the benchmark interest rate depending on market fluctuations – this new rate could decrease your monthly payments, though it is possible your payments may rise as well.

An ARM’s most impactful benefit is that the lower rates in the early part of the term can help borrowers qualify for more expensive homes that they could otherwise afford and offer a cheaper way for borrowers who don’t plan on living in one place for very long to buy a home.

Is a Fixed-Rate Mortgage for You?

Now that you know the difference between a fixed-rate mortgage and an ARM, you can weigh your options and ultimately decide which mortgage could benefit you the most.

Some questions to consider:

1. How long will you stay in your home?
2. What is the interest rate environment like?
3. Will your budget allow your monthly mortgage payment to rise?

The bottom line is if you plan to stay in a home for longer than 5 to 7 years and want a consistent monthly payment – specifically one that doesn’t fluctuate with the market – a fixed-rate mortgage could be the perfect fit for you.

Ultimately, you and your lender will decide on the best mortgage solution.

For questions about fixed-rate mortgages, or for general questions, speak with one of our mortgage experts today!