A Fixed Rate Mortgage, also known as its acronym FRM, is a fully amortized* loan where the interest rate is fixed in one spot, remaining the same throughout the duration of the loan. This is the opposite of what is known as an Adjustable Rate Mortgage loan, where the interest rate can float with the current market trends. There are other mortgage types such as; interest only mortgages, graduated payment mortgages, variable rate mortgages, negative amortization mortgage, and balloon mortgages, just to name a few.
What Makes a Fixed Rate Mortgage different?
Unlike a Adjustable Rate Mortgage a Fixed Rate Mortgage is not tied to an index. Instead as mentioned before the rate of collected interest is fixed in advanced for the duration of the loan, usually in increments of 1/4 or 1/8 percent. While Fixed Rate Mortgages are usually more expensive then Variable Rate Mortgages as they normally start with a higher interest rate, to guard against loss in the market if the index surges much higher than a low fixed rate.
This is known as an “interest rate risk” which has many determining factors. It should be noted that in a Fixed Rate Mortgage while you may be paying more than another Adjustable Rate Mortgage at the beginning of the payment cycles, you have effectively asked the bank to cover the “interest rate risk” and so pay a flat interest rate. In the Adjustable Rate Mortgage you shoulder the responsibility for the “interest rate risk” your self.
Term Choices When Choosing a Fixed Rate Mortgage:
There are two main choices when choosing the term of your mortgage loan, although others may be offered, it is normally narrowed down in a Fixed Rate Mortgage to either a fifteen year, or a thirty year term. A couple of differences in the two terms are;
- A 30 Year loan has lower monthly payments as your time to pay the loan back as the borrowers term is extended; though this is often times coupled with a higher interest rate and as such the borrower will pay more interest total over the span of the loan’s term.
- A 15 Year loan has higher monthly payments, as the loan’s term gives the borrower less time to pay the loan back. However the shortage of time means the borrower will pay a lower interest rate and in the end pay less interest over the span of the loan’s term.
*Amortized in banking and finance means that the principal of the loan is paid off during the term of the loan according to a fixed schedule, often called an amortization schedule, typically through equal payments.