Finance

Fixed-Rate Mortgage

Fixed-Rate Mortgage 

Fixed mortgage rates refer to a home loan that has a fixed interest rate throughout the term of the loan. This means the mortgage carries a constant interest rate from the beginning to the end. The term can be between 20 to 30 years which are popular for consumers who wish to know how much they will be paying throughout the period. Most fixed-rate mortgages are amortized. Other forms of mortgage loans include Interest-only mortgage, guaranteed payment mortgage, variable rate mortgage, negative amortization mortgage, & balloon payment mortgage.

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How Fixed-Rate Mortgage Work?

There are various kinds of mortgages available in the market such as variable, or adjustable-rate mortgages, or fixed-rate mortgages. In variable rate mortgage, the interest rates are not fixed but are set above certain benchmarks. On the other hand, a fixed-rate mortgage has a fixed rate of interest throughout the time of the loan. Most people who buy long-term loans such as home loans prefer fixed-rate mortgages. They prefer these mortgages as they are more predictable means borrowers know how much they will be paying every month and there are no surprises. Unlike adjustable-rate mortgages, fixed-rate mortgages don’t fluctuate with the market conditions they stay the same regardless of whether interest rates go up or down. The borrower usually seeks to lock lower rates to save money over time. When rates rise a borrower maintains lower rates compared to market conditions.

The amount of fixed-rate mortgage rates fluctuates depending on the term of the loan it is repaid. Long-term is charged more interest rates as compared to the short term. Hence someone with a term of 15 years will pay less interest than someone with a term of 30 years fixed-rate mortgage. In the initial stages of repayment, the mortgage borrowers pay more interest. Later on, more money is added to the principal.

Types of Fixed-Rate Mortgages:

  1. Auto Loans: An auto loan is a fixed-rate loan that requires borrowers to pay monthly payments over a specific period. In an auto loan, the buyer is required to keep the purchased vehicle as collateral. They agree to pay a pattern of payment which includes an initial downpayment and a continuous principal and interest payment.
  1. Mortgages: A mortgage is a type of fixed-rate loan that the buyer takes to buy a property or real-estate. In a mortgage agreement, the lender agrees to provide cash upfront in exchange for fixed monthly payments over some time. The borrower uses the loan to buy a house and only provides the property as the security of the loan until the full loan has been paid.

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Pros of Fixed-Rate Mortgage:

  • The monthly payment is the same until there is increased taxes or insurance.
  • As with adjustable-rate mortgages the borrower would not have to think about potentially higher payments.
  • In addition, pre-payment fees do not apply to most fixed-rate loans.
  • If the borrower feels the interest rates will increase over the next couple of years, it may be a good alternative because the rate is set and will not adjust without refinancing.

Cons of Fixed-Rate Mortgage:

  • There is varying risk involved in fixed-rate mortgages, for both lenders and borrowers. These risks are usually centered around interest rates. When the interest rate rises, a fixed-rate mortgage will have a lower risk for the borrower and a higher risk for the lender.
  • A fixed-rate mortgage can be disadvantageous since the interest rate could be higher than either an adjustable-rate loan or interest-only loan.
  • Another downside is that the principal is paid off at a slower rate as compared to an adjustable-rate mortgage.
  • Also, a lending bank would not benefit as much from the higher rates.

Bottom line:

Unlike the adjustable-rate mortgage, fixed-interest rates are not tied to an index. Instead, it is set to a fixed rate in advance to an advertised rate, usually in an increment of 1/4or 1/8 percent. The fixed monthly payment for a fixed interest rate is the amt paid by the borrower every month that ensures that the loan is paid off in full with an interest at the end of its term.

 

Author – Hariharan Krishnan

About the Author – Hariharan Krishnan is currently in second year BAF and is also doing FRM part 1. He is passionate about financial markets and loves to play chess and outdoor games.

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