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How does a fixed-rate mortgage work?

Yahoo Personal Finance· Getty Images
Laura Gariepy
6 min read

When it’s time to buy a house, you know you’ll need to borrow money from a mortgage lender. But did you know there are several mortgage loan types to choose from?

One of the most popular options on the market is the fixed-rate mortgage. We’ll explain how a fixed-rate mortgage works, share some pros and cons, and answer some common questions about these types of loans so you can decide if you want to finance your purchase with a fixed-rate home loan.

Learn more: What is a mortgage?

A fixed-rate mortgage is a home loan that has a stable interest rate for your entire term. If your interest rate is 7% on closing day, it will still be 7% decades later when you make your final mortgage payment — unless you refinance into a lower rate.

Your monthly principal and interest payments will remain the same for the entire term. (However, your overall mortgage payment may increase or decrease over the years due to property tax, homeowners insurance, or mortgage insurance changes.)

The alternative to a fixed-rate mortgage is the adjustable-rate mortgage (ARM). With an ARM, your interest rate stays the same for the first several years of the loan term. Then, based on multiple economic factors, it can increase or decrease at predetermined intervals until you refinance your mortgage, sell your home, or pay off your loan. Your monthly payment will change with each interest rate adjustment. For example, with a 5/1 ARM, your rate stays the same for the first five years and then goes up or down once per year.

Dig deeper: Adjustable-rate versus fixed-rate mortgage

Like any other home loan, a fixed-rate mortgage is a secured debt that uses your house as collateral. If you don’t repay your loan as agreed, the bank can foreclose on and sell the property to regain its losses.

Several types of fixed-rate mortgages are available. You can get a conventional mortgage, which you may consider a “regular mortgage.” You can also secure a government-backed home loan (FHA, VA, or USDA) with a fixed interest rate.

“To get a fixed-rate mortgage, you would first apply with the lender of your choice. You would then authorize a credit check and provide the requested documentation about your finances and current holdings,” said Scott Kuhn, head of mortgage retail sales for Members 1st Federal Credit Union, via email.

If you’re qualified for the mortgage, you can choose your loan term and interest rate from the options the lender provides. “Commonly available terms are 30 years, 20 years, 15 years, or 10 years,” said Kuhn.

Shorter terms typically come with lower interest rates, but your monthly fixed-rate mortgage payments will be higher because you’re paying off the same amount in a shorter chunk of time. If you want a lower monthly payment and are comfortable paying more in interest, you may prefer a longer fixed-rate mortgage term.

Your down payment also impacts your interest rate. Your lender will usually reward you with a lower interest rate if you put more money down because you’ll borrow less, which reduces the bank’s risk.

Typically, your fixed-rate mortgage is fully amortized, meaning you will pay off your mortgage at the end of the term if you make every payment in full and on time. It follows an amortization schedule, a document your mortgage lender will give you that shows how each payment is allocated toward the principal balance and interest due. You’ll also see exactly how much interest you’ll pay over the loan term.

Even though a fixed-rate home loan keeps your mortgage principal and interest payments the same, during the early years of your mortgage, more of each payment will go toward mortgage interest than principal. Gradually, more will go toward the principal and less toward interest so that as you near the end of your loan term, most of your payment will go toward the principal.

Let’s say you take out a 30-year fixed-rate mortgage for $300,000 with a 6.5% interest rate. When you make your first monthly fixed-rate mortgage payment of $1,896, only $271.20 will go toward the principal balance. However, when you make your last $1,896 payment in 30 years, $1,885.99 will go toward the principal.

When you have spare cash, you can pay down your loan faster (and reduce your interest charges) by making extra payments on the principal balance. For instance, paying an additional $1,896 each January will shave nearly six years off your loan term and save you over $86,000 in interest.

Now, let’s say you take out a 15-year fixed-rate mortgage with a 6% interest rate. Your monthly payment will jump to $2,532, but you’ll pay about $227,000 less in interest (and have a paid-off home in half the time).

Read more: 15-year versus 30-year mortgage

Like any financial product, the fixed-rate mortgage has its share of pros and cons.

Pros

  • Predictable monthly payments

  • No rate increases — even when the market shifts

  • You can refinance the loan if rates decrease

  • You'll typically have a higher rate than the initial rate you’d get with an ARM

  • There isn’t potential for your rate to drop like there is with an ARM

  • You need a sizeable down payment to get the best rate

As of spring 2024, the average 30-year fixed mortgage rate is around 7%. However, average rates change regularly, so you should keep tabs on them if you want to buy a house soon.

“[You] should choose a fixed rate or at least consider one when the rates are at historically low periods,” Kuhn said. “[You] should also consider [one] if [you] need payments that are stable to budget on a fixed income, whether that be salary, hourly, or retirement.” A fixed-rate mortgage may also be a good bet if you plan to keep the home for a long time.

A fixed-rate mortgage may be good for you if you want predictable monthly payments throughout your loan term and plan to stay in the home for a while. However, since adjustable-rate mortgages often have a lower initial interest rate, you may want to consider getting one if you plan to sell or refinance the property before the initial period ends.