If you’re new to the home buying game, you’re probably astonished at the amount of new lingo you need to learn. Do you want a fixed-rate or an adjustable-rate mortgage? And once you’ve figured that out, you need to determine what term works best for you. Is it 15 or 30 years or somewhere in between?
Before you can decide which type of mortgage is right for you, you need to learn more about your options. If you’re no fan of surprises and enjoy predictable payments, a fixed-rate mortgage may make sense for you. We’ll explore everything you need to know about fixed-rate mortgages and how they work.
A fixed-rate mortgage is a home loan option that offers a single interest rate for the entire term, or length, of a loan. The interest rate on the mortgage never changes over the loan’s lifetime, keeping the borrower’s interest and principal payments the same month to month.
Changes in the market won’t impact the rate, which explains why fixed-rate mortgages are the most popular mortgages in the U.S.
When it comes to fixed-rate mortgages, the name says it all.
When you get one of these mortgages, your interest rate stays the same the entire time you pay off the loan. In other words, the interest rate is fixed.
Fixed-rate home loans are the backbone of the mortgage industry for a lot of good reasons.
The main benefit of a fixed-rate mortgage is that your monthly mortgage payment – the amount you pay toward your mortgage principal and interest – will remain the same throughout the life of the loan.
However, two other parts that make up your monthly mortgage payment – homeowners insurance and property taxes – can go up or down, and your overall payment will change to reflect the new amount. These factors are outside your lender’s control, but your monthly mortgage payments will probably include these expenses. Your lender holds the additional expenses in an escrow account and pays them for you when they’re due. Having a lender take care of making these payments can help make your life easier, and it prevents missed property tax or insurance payments that can become a huge headache.
As you learn about fixed-rate mortgages, you’ll also hear the term “amortization.” Mortgage loans typically have a set length of time that dictates when they’ll be paid off.
For example, with a 30-year fixed-rate mortgage, after 30 years of on-time, monthly payments, your mortgage will be fully paid off. Because the rate is fixed, you’ll know exactly how much interest you’ll pay over the life of your loan. And because the mortgage term is 30 years, you’ll enjoy a low payment relative to the total loan amount.
How Does Amortization Work?
In the first few years of making mortgage payments, the majority of your payment will go toward paying off interest rather than the principal (the total loan amount).
Let’s say you have a fixed-rate loan, and your monthly payment is $1,500. When you begin paying off your mortgage, $1,400 of the $1,500 payment may go toward interest, and $100 will go toward the principal. But as you progress through the life of your loan, the payment allocation gradually shifts. At one point, you may pay an equal amount in interest and principal. By the end of the loan’s amortization schedule, you’ll pay more principal than interest. Toward the end, you may be paying $1,400 toward the principal and $100 in interest.
Fixed-rate mortgages have higher rates than the introductory rates adjustable-rate mortgages (ARMs) offer. You pay a bit more in exchange for the peace of mind provided by a low rate that’s locked in the entire time you’re paying off the loan.