Fixed rate mortgages are the most popular type of loan because they offer the borrower certainty over the life of the mortgage. As the name indicates, the mortgage rate and monthly payments for a fixed rate mortgage are set and do not change over the life of the loan. This means the borrower does not have to worry about an increase in interest rates and corresponding increase in monthly payment. Your mortgage rate and payment in the first month of the loan are the same as your rate and payment in the final monthly of the loan.
Fixed rate mortgages amortize over the term of the mortgage which means that with your final monthly mortgage payment, the loan is paid-off in full, with interest. Because of the way amortization works, a fixed rate mortgage has a constant payment over the life of the loan, but the split between interest and principal payments changes a little every month. An amortization formula determines how much of your payment goes toward paying the lender interest and how much of your payment goes toward paying down your principal loan balance.
At the beginning of the mortgage, the majority of your monthly payment goes to paying interest as opposed to reducing your principal balance. For a 30 year fixed rate loan, it takes approximately nineteen to twenty three years to pay down half of the loan, depending on the mortgage rate. The higher the mortgage rate, the longer it takes to pay down the mortgage balance.
The beauty of a fixed rate mortgage is its simplicity -- in order to evaluate a fixed rate mortgage you only need to understand two key concepts: mortgage rate and term. The mortgage rate is the fee you pay to the lender for borrowing the money and term is the length of the loan. The table below outlines these key concepts for a fixed rate mortgage.
The interest rate you pay on a fixed rate mortgage depends on several factors including your credit score, loan-to-value (LTV) ratio, loan term and mortgage type. Additionally, fixed rate mortgage rates tend to be higher than the initial interest rate for an adjustable rate mortgage (ARM) or interest only loan. Fixed rate mortgages are provided by traditional lenders such as banks, mortgage banks, mortgage brokers and credit unions. Shop multiple lenders in the table below to find the fixed rate mortgage with the lowest rate and fees.
Lenders typically offer fixed rate mortgages with 10, 15, 20, 25 and 30 year terms, with the 30 year term being the most popular. The shorter the term, the lower the mortgage rate but the higher the monthly mortgage payment because the principal amount of the mortgage is amortized, or paid back, over a shorter period of time. Although you pay a higher monthly payment with a shorter mortgage term, you minimize the total amount of interest you pay over the life of the loan. In other words, the shorter the mortgage term, the less interest you pay to the bank for borrowing the money. We review mortgage term and total interest expense in detail below.
The charts below demonstrate how the mortgage rate and monthly payment change depending on the term of the mortgage. The first chart illustrates the longer the term, the higher the interest rate while the second chart illustrates the longer the term, the lower the monthly mortgage payment.
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The amount of total interest expense you pay over the life of the mortgage is directly related to the length of the mortgage. The longer the mortgage term, the more you pay in total interest expense. So even though a mortgage with a shorter term has a higher monthly payment than a mortgage with a longer term, you end up paying much less in total interest expense with a mortgage that has a shorter term.
The chart below compares the monthly mortgage payment and total interest expense over the life of the mortgage for $400,000 fixed rate mortgages with a 4.00% mortgage rate and 10, 15, 20, 25, 30 and 40 year terms. As demonstrated by the chart, the shorter the mortgage term, the higher the monthly payment but the lower the total interest expense over the life of the loan. Selecting a shorter mortgage term can save you tens of thousands and even hundreds of thousands of dollars in interest expense over your mortgage. That means less money for the lender and more money for you.
One creative way to think about mortgage term is to get a loan with a longer term but make the same payment that you would with a shorter term mortgage, so a higher mortgage payment than what is required. For example, you get a 30 year mortgage but make the same, higher payment that you would with a 15 year loan. That way you maintain the flexibility of having a lower required monthly payment that goes along with a longer mortgage term (in case you cannot afford to make the higher payment at some point in the future), but you pay off your mortgage faster and potentially save a significant amount of money in lower interest expense.
Watch our video tutorial below to understand how a fixed rate mortgage works
Fixed Rate Mortgage Overview Instructional Video
Related FREEandCLEAR Resources
"Fixed-rate Mortgages." My Home by Freddie Mac. Freddie Mac, 2019. Web.