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What Is a Fixed-Rate Mortgage and How Does It Work?

TLDR

What You Need To Know

  • The term “fixed-rate mortgage” describes a mortgage loan with an interest rate that doesn’t change over the loan’s term
  • Whether interest rates soar or sink – the interest rate on your fixed-rate mortgage will never change
  • Around 90% of mortgages in the U.S. are fixed-rate mortgages[1]

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Unless you have the resources to buy a home with cash, applying for a mortgage is the usual way most aspiring buyers purchase homes that would otherwise be out of reach. 

For most home buyers, taking out a mortgage is a clear path to homeownership. But what may not be so clear is the type of mortgage buyers should use to purchase a home. 

The options are (literally) endless. Does a short-term or long-term mortgage make sense? Should you be looking at conventional loans or government-backed loans

We’re focusing on another key mortgage consideration: whether you should apply for a fixed or an adjustable-rate mortgage (ARM).

Spoiler alert: around 90% of mortgages in the U.S. are fixed-rate mortgages.[1] In other words, it’s highly likely you’ll end up choosing a fixed-rate mortgage. But that doesn’t mean you shouldn’t know everything about them – and why they’re so popular with home buyers.

Fixed-Rate Mortgage: A Definition

With a fixed-rate mortgage, the loan’s interest rate is locked in over the life of the loan. With an ARM (aka a variable-rate mortgage), the loan’s interest rate may rise (or fall) based on changes in the broader financial markets.

Fixed-rate mortgages are the most popular mortgage option in the U.S. One of the reasons why is the predictable monthly payments. But fixed-rate mortgages have their fair share of drawbacks, including slightly higher interest rates. 

How Fixed-Rate Mortgages Work

When you apply for a mortgage, your mortgage lender will offer an interest rate. Several factors can affect the mortgage rate your lender offers, including the mortgage term (usually 30 or 15 years), your credit score and the size of your down payment.

Also, one key factor that affects interest rates overall is the federal funds rate. It creates a “floor” or baseline for the interest rates set on all new mortgages. 

The good news? For homeowners with fixed-rate mortgages, the instability is less of a concern. Whether the Fed changes rates or not – the interest rate on your fixed-rate mortgage will never change. Your rate is fixed for your entire mortgage term.

What Types of Fixed-Rate Mortgages Are There?

Fixed-rate mortgages come in a variety of forms.

  • VA loans: The Department of Veterans Affairs offers fixed-rate mortgages to qualifying veterans, active-duty service members and surviving spouses. 
  • USDA loans: The U.S. Department of Agriculture offers borrowers fixed-rate mortgages they can use to purchase or build a home in qualifying rural communities.
  • FHA loans: The Federal Housing Authority offers a variety of mortgages, including fixed-rate mortgages. While FHA loans are available to all home buyers, they are typically aimed at first-time home buyers and home buyers with past savings or credit issues.
  • Conventional loans: The majority of mortgages in the U.S. are conventional mortgages, which means they aren’t government-backed. Fixed-rate conventional loans typically require at least a 3% down payment and a credit score of 620 to qualify.
  • Jumbo loans: If you plan on buying a home that exceeds the Federal Housing Finance Authority’s conforming loan limit, you’ll need to use a jumbo loan or a nonconforming loan.

You can access fixed-rate mortgages through a variety of agencies and loan programs.

What Are Common Fixed-Rate Mortgage Terms?

The term “fixed-rate mortgage” describes a mortgage loan with an interest rate that doesn’t change over the loan’s lifespan. 

But your loan’s “term” is how long a lender gives you to pay off your mortgage. If you make extra payments, you can pay off your mortgage before the term is up.

30-year fixed-rate mortgage

The reigning champion of mortgages in the U.S. is the 30-year fixed-rate mortgage. The loan combines the benefit of a longer-term mortgage (think: low monthly payments) with the benefit of a fixed rate (think: predictable monthly payments). 

15-year fixed-rate mortgage

The 15-year fixed-rate mortgage is another popular option. 

With a 15-year fixed-rate mortgage, you’ll get a slightly lower interest rate than you would with a 30-year loan, but your monthly mortgage payments will be higher because you’re paying off the loan for a shorter time.

You’ll pay off your mortgage sooner – and pay much less in interest. 

Other fixed-rate mortgage terms

When you look at the mortgage landscape, 30-year and 15-year mortgages dominate the market. But they aren’t your only loan term options. Depending on the lender, you can apply for a 20-year mortgage, a 10-year mortgage or even shorter loan terms.

Fixed-Rate Mortgage vs. Adjustable-Rate Mortgage

If you don’t have a fixed-rate mortgage, the loan’s interest rate can change – making the loan an ARM. 

The key difference between fixed-rate and ARMs is what happens to the interest rate over the life of the loan. With a fixed-rate mortgage, your interest rate stays the same. But with an ARM, your interest rate would adjust depending on changes in the market.

Pros and Cons of Fixed-Rate Mortgages

So, is a fixed-rate mortgage right for you? Let’s take a closer look at the benefits and drawbacks of fixed-rate mortgages.

PROS of Fixed-Rate Mortgages👍

Consistent payments

With a fixed-rate mortgage, you can be confident that your interest rate and principal payments will remain unchanged for the duration of the mortgage. Because your monthly mortgage payment never changes, it’s easier to include the recurring payment in your budget.

Loan paid in equal installments over time

Mortgage amortization is the schedule of monthly loan payments you must make to pay off your loan. With a fixed-rate mortgage, your monthly mortgage payment will stay the same.

Protection against interest rate increases

Market interest rates can start to climb for any number of reasons. Since we can’t forecast what the economy will look like in 30 or 15 years (much less 30 or 15 minutes), a fixed-rate mortgage is the best protection against rising interest rates.

CONS of Fixed-Rate Mortgages👎

Higher initial monthly payments

Because ARM loan repayments start with an introductory rate that is typically lower than the average fixed-mortgage rate, your monthly mortgage payments will likely be lower than they would be with a fixed-rate mortgage. But once the ARM’s intro period ends, the loan’s interest rate could change.

Can’t take advantage of drops in interest rates

If you have an ARM loan, your monthly mortgage payment may decrease when interest rates drop. For better (or maybe worse), your payment will stay the same with a fixed-rate mortgage.

Can You Refinance a Fixed-Rate Mortgage?

The loan term on your mortgage agreement might say 30 years, but that doesn’t mean you’re obligated to take all 30 of those years to pay off your loan. If interest rates drop while you’re still chipping away at your mortgage, you may want to consider refinancing your mortgage.

Most homeowners take advantage of refinancing (read: replace your original mortgage with a new mortgage) to lower their interest rate, reduce their monthly mortgage payment and shorten their loan term. 

While the advantages of refinancing may sound great (and they are), refinancing isn’t free. You should weigh whether the benefits of refinancing are worth the closing costs you’ll pay to refinance. 

Fixed-Rate Mortgages: The Reliable Option

Fixed-rate mortgages aren’t the only option available to home buyers. But they offer a crucial benefit that makes fans of many aspiring homeowners: predictable monthly mortgage payments over the life of the loan.Of course, you should explore all your mortgage options before you make a final decision, but fixed-rate mortgages are a common starting point for first-time home buyers ready to begin their homeownership journey.

  1. Freddie Mac. “Choosing Between a Fixed-Rate and an Adjustable-Rate Mortgage.” Retrieved December 2022 https://myhome.freddiemac.com/blog/homeownership/choosing-between-fixed-rate-and-adjustable-rate-mortgage

ICYMI

In Case You Missed It

  1. You can refinance a fixed-rate mortgage to lower the interest rate and shorten (or extend) the loan’s term

  2. With a fixed-rate mortgage, your interest rate and principal payments won’t increase, but they won’t decrease if interest rates drop

  3. A 15-year fixed-rate mortgage can offer a lower interest rate than a 30-year fixed-rate mortgage, but will have higher payments

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