What is a Fixed Rate Mortgage: All You Need to Know

Navigating the world of mortgages and banking can seem complex, if not downright intimidating. Even people who know a lot about money might have trouble understanding how a fixed-rate mortgage works. You likely already understand some basics but might not be fully informed on all its details and nuances. That’s why we’re here: taking the time to comprehend these important details will save you money in the long run. Taking the time to comprehend everything involved will pay dividends, so read on to discover what a fixed-rate mortgage is, how it works, and other essential info.

What is a fixed-rate mortgage?

A fixed-rate mortgage is one of the most popular and widely used types of mortgage. With this loan, the interest rate remains fixed throughout its entirety, making budgeting more straightforward since you know exactly how much money needs to be paid each month throughout its duration. Furthermore, since rates don’t fluctuate, borrowers also enjoy protection from rising costs.

On the other hand, some may view this as a risk due to potential missed opportunities if rates decline during your loan term. Also, fixed-rate mortgages aren’t very flexible when it comes to taking advantage of lower rates because there aren’t many ways to pay off the loan early or switch lenders.

Pros and Cons of a Fixed Rate Mortgage

Before opting for a fixed-rate mortgage, weighing the pros and cons is essential. On the one hand, one significant advantage is that rates won’t rise over time; this simplifies budgeting for long-term loans since homeowners know precisely how much their payments will be in the long run. Also, fixed-rate mortgages have predictable payments and low risk, meaning borrowers often get lower interest rates than other loans or loans with variable rates.

However, there may be some potential drawbacks to take into account. Fixed-rate mortgages make payments predictable because they are made at the same time every month over the life of the loan. However, this could mean that homeowners pay more in principal and interest each month than if they had chosen an adjustable-rate mortgage with a lower current interest rate. Also, depending on how the market is doing when you get your loan, selecting a fixed rate may cost you more upfront, depending on how the market is doing.

Benefits of Fixed Rate Mortgages

Fixed-rate mortgages offer many financial advantages to homeowners. The fact that monthly payments stay the same over the life of the loan may be the most significant and most appealing benefit. This makes budgeting easier and reduces stress for homeowners. Furthermore, since interest rates don’t change, homeowners reduce their risk of experiencing rising rates, which could cause payments to go up significantly and make managing a loan payment difficult for some individuals.

Since fixed-rate mortgages offer homeowners the stability of knowing exactly how much they will pay each month, they can accurately plan expenses and other items in their budget. This is not as easily done with variable-rate mortgages or when interest rates are rising. Moreover, homeowners could build equity faster over time due to predictable payments and an accurate understanding of when they will fully own their home.

Another benefit is that most fixed-rate loans don’t have prepayment penalties which means that if a homeowner pays extra on their loan, they won’t be charged extra. This could help them pay off their debt faster and save money on interest. While all these advantages can be beneficial, having access to adjustable-rate mortgages as a backup plan gives homeowners more choices. Therefore, make sure you weigh your options before deciding which type is best for your situation.

After discussing both sides of the argument when considering a fixed-rate mortgage, consider both the short- and long-term consequences of taking out such a loan. Look into expenses associated with purchasing a home, such as closing costs, tax implications, and more, that come along with either type of loan when considering the pros and cons. Now let us address the potential drawbacks associated with fixed-rate mortgages.

Disadvantages of Fixed Rate Mortgages

While fixed-rate mortgages have many benefits, it’s also essential to weigh the potential drawbacks. For instance, some homebuyers may face higher upfront fees like points and origination fees if market conditions allow. Also, someone may be able to get a lower interest rate on an adjustable-rate mortgage (ARM) than on a fixed-rate mortgage. This could save them hundreds of dollars a month in payments, but rates could go up in the future, making payments much more expensive in the long run.

Now that we have reviewed the advantages and drawbacks of a fixed-rate mortgage, let’s take a look at what happens if interest rates change when you take out such an arrangement. This topic will be explored further in the following section.

At the start of 2020, Freddie Mac reported an average rate for a 30-year fixed-rate mortgage at 3.04%. According to data compiled by the Mortgage Bankers Association in August 2020, 83% of U.S. homeowners with mortgages had secured these loans at fixed rates.

A 2019 study revealed that homeowners with fixed-rate mortgages were more likely to remain in their homes for extended periods than those with other loan types.

What Happens If Interest Rates Change?

One major disadvantage of a fixed-rate mortgage is that it does not take advantage of falling interest rates. If rates decrease after the loan has been taken out, borrowers would no longer benefit from lower payments. This argument comes up often because lenders make a lot of money when they sell old mortgages at higher rates. On the other hand, borrowers could refinance their home with another loan at a lower fixed rate if they qualify.

If interest rates drop significantly, refinancing a mortgage may not be the best choice. Instead, you might want to look into getting more loans. These loans could potentially offer lower interest rates than what’s currently on an existing mortgage. Since lenders’ offers vary significantly, and many come with various fees and closing costs, understanding all terms and conditions is vital in ensuring any new mortgage benefits both short- and long-term plans.

Interest Rates

Lower interest rates benefit both borrowers and lenders.

When interest rates are low, it benefits both lenders and borrowers alike. With lower rates, lenders can offer their customers better terms, which makes loans more appealing. On the other hand, borrowers benefit from lower rates since they pay less each month on their loans. This happens, for example, when the Federal Reserve lowers borrowing costs for homebuyers or refinancers by cutting mortgage costs based on the size of the loan. This can result in monthly savings depending on the kind of savings consumers receives each month based on their mortgage size.

Also, if lenders offer lower interest rates, they can make more money on loans and reach a broader range of customers. With lower rates, more people might be willing to take out loans, giving them a more diverse portfolio of loans and more ways to make money.

Now that you understand how interest rate changes affect fixed-rate mortgages, you can move forward to determine which kind of mortgage best meets your needs, and we’ll provide assistance in doing so in our next section.

Selecting the Right Mortgage for You

Everyone’s situation is unique, and what makes sense for one borrower may not work for another. We can help you evaluate your long-term personal, financial, and professional goals to decide what is best for you. 

Borrowers who prefer more stability may opt for a fixed-rate mortgage because it gives them certainty about their monthly payments over the life of the loan. Furthermore, if you plan to stay in your home longer than five years, locking in a lower interest rate could save you money in the long run.

Adjustable-rate mortgages offer greater flexibility, which could make them attractive if you plan to relocate or refinance within five years. They usually start out with lower interest rates, which could make their payments much lower over time compared to fixed-rate mortgages. Consumers need to remember that their rates and payments may increase if interest rates rise at some point during their loan lifecycle.

If you’re in the market for a mortgage, contact Smart Money Inc. to find out if a fixed-rate mortgage or an adjustable-rate mortgage would be better for you. 

To learn more about our mortgage options, call us today at (808) 447-1850. Our experienced mortgage professionals are here to guide you through the process and help you make the best decision for your financial future. Don’t hesitate and take your first step towards homeownership today!