How a Fixed-Rate Mortgage Works and When It Makes Sense
Buying a home often starts with choosing the right mortgage. Fixed-rate mortgages are the most popular option, historically accounting for the vast majority of home loans. With this type of mortgage, your interest rate stays the same for the entire loan term, making your principal and interest payments predictable.
Your monthly payments will stay mostly predictable, though you may have slight changes due to costs like property taxes and homeowners insurance. This stability can make it easier to budget for your monthly bills and long-term mortgage costs.
Here’s a closer look at how fixed-rate mortgages work, along with the pros and cons of fixed-rate mortgages, so you can determine if this type of loan is right for you.
What Is a Fixed-Rate Mortgage?
So, what is a fixed-rate mortgage, and how does it work? As the name suggests, the interest rate on a fixed-rate mortgage is locked in at closing. Your rate will not change over the life of the loan, regardless of what’s going on in the market.
“Fixed-rate mortgages win on one thing above everything else: predictability,” says certified financial planner (CFP) Jeff Judge. “Your principal and interest payment is the same in month one as it is in month 300.”
Most fixed-rate mortgages have set repayment terms of 15, 20 or 30 years. A 30-year term is the most common option, as it offers the most affordable monthly payments.
How Does a Fixed-Rate Mortgage Work?
Most fixed-rate mortgages are amortizing loans, which means a portion of your monthly payment goes to your principal balance while the rest goes to interest.
At the beginning of your loan term, more of your monthly payment will go toward paying off interest charges. As you pay down your loan, the balance will shift so that more of your payment goes toward the principal.
Your loan servicer takes care of allocating your payment — you don’t have to do anything except pay it. But if you’re interested, you can see your mortgage’s amortization schedule by logging into your online account or requesting one from your lender.
What Makes Up a Fixed-Rate Mortgage Payment?
Your full monthly mortgage payment may cover more than just your loan. If you have an escrow account, it typically includes your property taxes and homeowners insurance in addition to principal and interest. These four costs are often referred to as PITI, which stands for principal, interest, taxes and insurance. If you’re required to pay mortgage insurance, that cost may be added to your monthly payment as well.
Principal
Your principal is your mortgage balance. Part of your monthly payment goes toward paying down your loan.
Interest
Interest is the cost of borrowing money. It will accrue at the same fixed rate over the life of your mortgage.
Taxes and Insurance (PITI)
If your property taxes and homeowners insurance are paid through an escrow account, part of your monthly mortgage payment will go toward these costs. If you make a down payment of less than 20% on a conventional home loan, you may also have to pay private mortgage insurance (PMI), which can add roughly 0.5% to 1.5% of your loan amount in costs each year.
PMI is generally canceled automatically when your mortgage balance is scheduled to reach 78% of your home’s original value, as long as you’re current on your payments. You can typically request to have PMI removed once your balance reaches 80% of the home’s original value, provided you meet your lender’s requirements.
Tip: A fixed-rate mortgage only guarantees predictable principal and interest payments. Your total housing costs can still change if your property taxes, insurance premiums or homeowners association fees go up or down.
How Interest Works Over Time
When you take out a home loan, a large part of your early payments will go toward interest charges. Over time, a bigger chunk of your monthly payments will shift toward paying down the principal. As your balance falls, more of each payment will help build your home equity, or the amount of your home that you own outright.
Let’s say, for example, that you take out a 30-year, $300,000 mortgage at a fixed interest rate of 7%. In your first year of repayment, only about $250 of your nearly $2,000 monthly payment will go toward the principal, while about $1,750 will go toward interest.
In your last year of repayment, about $1,860 to $1,984 will go toward the principal, while only about $12 to $135 will go toward remaining interest charges. In total, you’ll pay $418,527 in interest charges, more than the initial amount borrowed.
You may be able to lower costs if you can refinance to a lower rate at some point during the repayment term.
Fixed-Rate vs. Adjustable-Rate Mortgage
Another type of mortgage is an adjustable-rate mortgage, or ARM. Unlike with a fixed-rate mortgage, your interest rate on an ARM can go up or down depending on market conditions.
ARMs often offer lower introductory rates than fixed-rate mortgages, which could save you money, especially if you plan to pay off your mortgage quickly or sell your home within a few years.
“With ARMs, the initial rate is almost always lower, sometimes by a full percentage point or more,” says Judge. “For a short-term hold — under seven years — that’s real money.”
Future changes are unpredictable, though, so there’s the risk of a substantial increase in your monthly payments and overall borrowing costs. If you prefer predictable monthly housing costs, a fixed-rate mortgage may be a better fit.
Pros and Cons of Fixed-Rate Mortgages
A fixed-rate mortgage can make sense if you prefer stable monthly payments, are generally risk-averse or plan to stay in your home long-term. It can also be wise to lock in a low rate when mortgage rates are low and expected to increase in the future.
On the flip side, a fixed-rate mortgage may not be ideal if you plan to sell your home or refinance your mortgage within the next few years. An ARM may be preferable to a fixed-rate loan if you expect your income to increase or plan to pay off your mortgage quickly.
Here are some pros and cons of fixed-rate mortgages to help guide your decision.
Pros
- No risk of interest rate increasing
- Predictable principal and interest payments
- Easier for monthly and long-term budgeting
- May be a good fit for long-term homeowners
Cons
- Fixed rate may start higher than the rate on an ARM
- You won’t benefit if market rates fall (unless you refinance)
- Could cost more than an ARM in some circumstances
Common Fixed-Rate Mortgage Terms
When you take out a mortgage, you can often choose a repayment term of 15 or 30 years.
30-Year Fixed
What is a 30-year fixed mortgage? It’s simply a fixed-rate mortgage that spreads out repayment over 30 years, or 360 monthly payments. If you take out a 30-year mortgage in 2026, for example, you’ll finish paying it off in 2056.
The vast majority of borrowers — nearly 90%, according to Freddie Mac, a government-sponsored mortgage company — opt for a 30-year term. This long term will give you more affordable monthly payments, but the tradeoff is higher interest costs over time.
You may be able to pay off your loan faster with extra payments, but find out if your lender charges prepayment penalties.
15-Year Fixed
A much smaller group of borrowers opt for a 15-year term. This shorter term will reduce interest costs and grow your equity faster, but you’ll have much higher monthly payments.
It could make sense if you have strong cash flow and are confident about your ability to afford the monthly payments.
What Affects Your Fixed Mortgage Rate?
A variety of factors affect your fixed mortgage rate, including:
- Credit score: A higher credit score can help you qualify for a better rate, since lenders see you as a less risky candidate for a loan.
- Down payment: Making a larger down payment also reduces lender risk and can help you lock in a lower interest rate.
- Loan type: Interest rates can vary depending on the type of mortgage you choose, whether a conventional home loan, FHA loan, VA loan, USDA loan or other type.
- Market conditions: Conditions like inflation and Federal Reserve policy influence the rates that lenders charge. Mortgage rates change frequently, often differing from one day to the next.
Bottom Line
A fixed-rate mortgage offers predictability, which can make it easier to budget for housing bills and plan for long-term financial goals. Your loan will follow a clear payoff schedule, and you won’t have to worry about your rate increasing over time.
The right choice depends on various factors, including your goals and market conditions. If you’re focused on lower initial payments or short-term home ownership, an ARM may be the more cost-effective choice.
By comparing your options, you can choose a mortgage that fits your timeline, budget and risk tolerance.
Fixed-Rate Mortgage FAQs
What Is the Main Benefit of a Fixed-Rate Mortgage?
The main benefit of a fixed-rate mortgage is predictable, stable monthly payments that you can easily budget for. There’s no risk of your interest rate increasing if market rates rise.
Is a Fixed-Rate Mortgage Better Than an ARM?
When it comes to a fixed vs. adjustable-rate mortgage, a fixed-rate mortgage isn’t necessarily better — it all depends on your circumstances. A fixed rate may be preferable if market rates are low or you’re planning to stay in the home long-term, while an adjustable rate may be better if you’re more risk tolerant or can pay off your mortgage (or sell your home) in a short period of time.
Can Your Payment Change With a Fixed-Rate Mortgage?
Your monthly payments can change if your taxes, homeowners insurance, PMI fees or homeowners association dues change, since these are all part of your monthly mortgage bills. However, your principal and interest payments won’t change with a fixed-rate mortgage.
What Is the Most Common Fixed-Rate Term?
The most common fixed-rate term is a 30-year term. Nearly 90% of mortgage borrowers opt for a 30-year repayment term.
Can You Pay Off a Fixed-Rate Mortgage Early?
You can pay off a fixed-rate mortgage early, but some lenders charge prepayment penalties, especially in the early part of your term. Consult your mortgage agreement or contact your lender to find out about any early payment fees.
Can You Refinance a Fixed-Rate Mortgage?
You can refinance a fixed-rate mortgage as long as you can meet a lender’s requirements, such as a minimum credit score and income. Refinancing may help you lower your interest rate, adjust your monthly payments and change your repayment terms.
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Reporting by Rebecca Safier, Special to USA TODAY / USA TODAY
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