Definition
A fixed-rate mortgage is a home loan where the interest rate remains constant for the entire duration of the loan term, resulting in stable and predictable monthly payments for principal and interest. This stability helps borrowers budget effectively, as the payment amount does not change even if market rates fluctuate.
How Fixed-Rate Mortgages Work
- Borrowers lock in a fixed interest rate when they close on the mortgage.
- The monthly principal and interest payment stays the same for the entire loan period.
- Early in the mortgage term, most of the payment covers interest; over time, more goes toward reducing the principal.
- Typical loan terms are 15, 20, or 30 years, though some lenders offer terms from 8 to 40 years.
Real-World Examples
- 30-Year Fixed Mortgage Example
Jill takes a $300,000 mortgage at a 6.8% interest rate for 30 years. Her principal and interest payment is $1,956 monthly. Initially, only $255 reduces her loan principal, while the rest covers interest. After 20 years, about half the payment cuts the principal, and near the end, most goes to principal with minimal interest.
- Refinance to Lower Fixed Rate
Donna had an 8.5% interest rate on a 30-year mortgage but struggled to reduce her loan principal. Refinancing to a 20-year fixed loan at 3.25% helped her lower total interest costs and pay off the mortgage faster while maintaining affordable monthly payments that now include escrow for taxes and insurance.
- 30-Year vs. 15-Year Fixed Mortgage
Borrower A takes a $380,000 loan at 6.44% interest for 30 years, paying $2,716 monthly and $479,278 in total interest. Borrower B takes the same loan amount for 15 years at 5.63%, paying $3,460 monthly but only $183,615 in total interest, cutting the loan length and total cost significantly.
Advantages and Disadvantages
| Advantages | Disadvantages |
|---|
- Predictable monthly payments aid budgeting
- Protected against rising interest rates
- Various fixed-term lengths available
| - Usually have higher initial interest rates than variable loans
- No benefit if interest rates fall during the loan term
- Early repayment often incurs penalties
|
Additional Notes
- Fixed-rate mortgages expose borrowers to inflation risk: borrowers benefit if inflation rises (real value of payments declines) but lose if inflation and rates fall.
- In some countries, fixed-rate terms often last 2–5 years before reverting to variable rates unless refinanced.
- Property taxes and homeowners insurance typically are paid separately or escrowed, so total monthly housing payments may vary even with a fixed principal and interest mortgage payment.
