What is a fixed-rate mortgage and how does it work?

Not all mortgages are created equal when it comes to the interest they charge: some offer fixed rates, while others have fluctuating rates. In the U.S., the most common loan type by far is the fixed-rate mortgage. Yet even with fixed-rate loans, there are a variety of options.

Let’s look more closely at what fixed-rate mortgages are, how they work, and how they differ from adjustable-rate mortgages.

What is a fixed-rate mortgage?

A fixed-rate mortgage means that the interest rate stays constant throughout the entire loan period, or term. These loans are popular because they provide predictability. With a fixed-rate mortgage, your monthly payment for principal and interest remains consistent, so you always know how much is due. Although some additional costs like homeowners insurance and property taxes may cause slight variations in your total monthly payment, the core loan payment remains the same, enabling you to budget and plan more efficiently.

While 30-year terms are the most common, you can also find options for 20-year, 15-year, and 10-year loans. Additionally, many lenders offer even more flexible terms ranging from eight years to 40 years.

How fixed-rate mortgages work

The prevailing mortgage rates that lenders advertise are always moving up and down due to several factors. So, you might see an offer for a 7.5 percent interest rate today and a 7.75 percent interest rate tomorrow. However, with a fixed-rate mortgage, once you lock in your rate and close on your home, that movement doesn’t impact you. No matter what happens after you secure your loan, your rate remains the same.

While a fixed-rate mortgage’s monthly payment amount stays the same, the breakdown of where those funds go — how much is paying down the principal versus how much is paying interest charges — varies based on the loan’s  amortization schedule. At first, it’s going mostly towards interest, then  gradually applies in increasing amounts to the principal.

For instance, if you make a 20 percent down payment on a $375,000 home and take out a $300,000 30-year fixed-rate mortgage at 7.5 percent interest, your monthly payment (excluding insurance and taxes) would be $2,097 for the entire 30 years. In the first month, only about $220 of your payment would reduce the actual loan amount (principal), while the rest covers interest. Twenty years later, $984 (or nearly half) of your payment would be applied to the principal. By late 2044, less than half of the payment would be towards interest. This is how you build home equity, or outright ownership, in the property over time.

Pros and cons of a fixed-rate mortgage

Choosing a fixed-rate mortgage for your new home has its upsides and downsides to think about.

Types of fixed-rate mortgages

There are also different types of mortgages  to be aware of before exploring your options:

• Conventional: Conventional  fixed-rate mortgages usually have stricter requirements, such as a minimum 620 credit score and a debt-to-income ratio no higher than 43 percent, with some exceptions. These loans are offered by banks, credit unions, online lenders, savings and loans associations, and mortgage companies.
• Government-backed: FHA loans, VA loans and USDA loans are all insured or guaranteed by a federal agency, which recompenses the lender if the borrower defaults. FHA loans are available to all, even if they have low credit scores, USDA loans are designed for specific borrowers in rural areas, and VA loans are for military service members, veterans, and eligible family members.
• Conforming: Conforming loans adhere to Federal Housing Finance Agency (FHFA) requirements, including loan limits, allowing them to be sold on the secondary market. Meeting these standards enables the buying and selling of these loans to keep money flowing in the mortgage market.
• Non-conforming: Non-conforming loans, including jumbo loans, do not meet certain FHFA requirements. To qualify, you might face a higher interest rate and stricter requirements related to your credit score and cash reserves.
• Amortizing: The majority of fixed-rate mortgages are amortizing loans. This means that your monthly installment payments contribute to both the principal and interest. While the amount remains the same throughout the loan’s term, the portion of your payment that goes to the principal differs from the amount applied to interest, gradually increasing so that you pay off the loan in full by the term’s end.
• Non-amortizing: Less common, non-amortizing loans offer lower monthly payments that may cover only the interest for a set period. When the interest-only period ends, there’s often a balloon payment, a large lump sum that covers all or most of the principal.

Fixed-rate mortgage term options

You’ll repay your fixed-rate mortgage over a set period.

• 30-year fixed-rate mortgage: This is the most common mortgage term, allowing you to spread your home loan payments over three decades. Although it might seem like a lengthy period, this extended timeline reduces your monthly payment size, creating more space in your budget.
• 15-year fixed-rate mortgage: A 15-year fixed-rate mortgage typically comes with a lower interest rate than the 30-year. However, you’ll need to repay the loan in half the time. This option is suitable for borrowers with strong cash flow who aim to pay off their homes faster and minimize interest payments.
• Other fixed-rate mortgage terms: Some mortgage lenders also offer more customized loan terms, ranging from eight to 30 years.

While the term attached to a fixed-rate mortgage is the maximum amount of time you have to repay it, you can also opt to contribute additional money toward the principal to shorten your pay-back period. Just make sure your loan doesn’t have a prepayment penalty (most don’t), and that the extra payments are actually going towards reducing the principal.

Fixed-rate mortgage example

Meet Jill, a newcomer to homebuying who’s ready to transition from renting. After doing some budgeting, Jill has figured out that she can comfortably handle about $1,200 each month for her mortgage, covering principal and interest.

By working in reverse from this monthly budget, we can estimate the amount Jill could potentially borrow with two different fixed-rate mortgages. (Note: We haven’t considered a down payment or closing costs in this example.)

For about the same monthly payment, Jill can borrow $35,000 more with a 30-year fixed loan compared to a 15-year loan.

Now, imagine that Jill’s budget and excellent credit enable her to select the $175,000 loan, regardless of the loan duration. If she decides on a 30-year fixed-rate mortgage, she’ll face a higher interest rate but gain the flexibility of a more extended repayment period. However, this convenience of a longer term comes with a significant downside — a considerably larger total cost in terms of interest charges:

If Jill can afford the higher monthly payments of a 15-year mortgage, she’ll save over $181,000 in interest. But if those monthly payments are unaffordable, she may be better off with the 30-year loan.

You can use Bankrate’s mortgage calculator to find the amortization table for a sample loan based on the home price, interest rate, loan term, and down payment.

Fixed-rate mortgages vs. adjustable-rate mortgages

Though the most popular among Americans by far, fixed-rate mortgages aren’t the only loan in town. Another option: adjustable-rate mortgages (ARMs), whose interest rate fluctuates with prevailing market rates. There are a variety of considerations when weighing adjustable-rate loans over fixed-rate ones.

Interest rates

With a fixed-rate mortgage, the interest rate never changes. In contrast, many ARMs start with an introductory, fixed interest rate for a specific period. After that period, the interest rate adjusts at regular intervals, usually every year or six months. The direction of the rate change (up or down) depends on whatever interest-rate index the loan is based on.

Usually, changes on the rate on your ARM are capped: They can’t increase by more than a stated percentage with each adjustment, nor by a certain amount over the life of the loan. For example, if you start out with an ARM at 7 percent, the cap might limit the overall interest rate to 12 percent over the loan term.

Risks

ARMs are generally riskier than fixed-rate mortgages: The interest rate for an ARM can fluctuate, making payments unpredictable, whereas the rate for fixed-rate mortgages never changes. And of course, if your ARM rate increases, you will pay more in interest on the money borrowed.

Length of the time in the home

ARMs are more intricate loans and are generally more suitable for borrowers who probably will move after a few years — ideally, while the ARM is still in its fixed-rate phase (so they never encounter the potential increase of a fluctuating rate). If you plan to stay in your home for an extended indefinite period, a fixed-rate mortgage might be a better option.

To better illustrate the differences between a fixed-rate mortgage and an ARM and how your mortgage payment can change over time, let’s revisit our friend Jill.

First, let’s assume she opted for a 15-year fixed-rate mortgage loan for which she borrowed $140,000 at 6.82 percent; over the life of that loan, she would have paid a total of $83,976 in interest. Here’s the amortization table that breaks down her total payments:

Now let’s say Jill chose a 5/1 ARM instead, with an initial five-year fixed rate of 6.83 percent (on the same $140,000). Assuming an expected yearly adjustment of at least 0.25 percent and an interest rate cap of 12 percent, she might pay $90,834 in total interest over those 15 years. However, it’s impossible to predict how the yearly rate might adjust over this term, so Jill could pay more or less than that in interest. Here’s an amortization table that demonstrates her total payments:

Should you get a fixed-rate mortgage?

A fixed-rate mortgage is a good solution for many homebuyers. In general, this type of loan can be a smart choice for people who want consistent payments over the lifetime of their loan, and interest rates that will remain constant. Fixed-rate mortgages also tend to be ideal for people who plan to stay in the same home for a long period.

Although it’s long been America’s go-to loan, the fixed-rate mortgage may not be right for every homebuyer, however You pay a lot in interest — especially in the loan’s early years. You’re locked into a rate for decades, and the only way to reduce it (should prevailing rates fall) is to refinance. If you don’t think the house you’re buying will be your forever home, taking advantage of the lower rates of ARMs could be a smarter move.

FAQ about fixed-rate mortgages

• What are current rates for fixed-rate mortgages?

  According to Bankrate’s survey of the largest mortgage lenders in the U.S., at the end of May, the average 30-year fixed mortgage rate is 7.17 percent; the average 15-year fixed mortgage rate, 6.63 percent; the average 10-year mortgage rate, 6.59 percent.
  

• What are alternatives to fixed-rate mortgages?

  The most common alternative to the traditional fixed-rate mortgage is an adjustable rate mortgage (ARM). You might also consider:
  
  

  • a balloon mortgage, in which you pay off most of the principal at the end of the loan term
  • an interest-only mortgage, in which you just make interest payments for several years, followed by payments for both principal and interest
  • a home equity line of credit (HELOC), in which you borrow against your ownership stake at a variable rate if you already have a home and want to finance another
  • a construction loan, a form of short-term financing, if you’re building a new home