A fixed rate mortgage is a mortgage in which the interest rate remains the same over the life of the loan. In other words, if someone takes out a 30 year mortgage with an interest rate of six percent, he or she will pay six percent interest on the loan until it is paid off. This type of mortgage is often viewed as the most low-risk and the most basic, and it appeals to many people who are interested in purchasing property, especially first time buyers.
The obvious advantage to taking out a fixed rate loan is that the monthly payments will remain the same throughout the loan, which allows people to make better budgeting decisions and think ahead. Fixed rate mortgages also protect borrowers from increases in interest rates, because when the interest rate on the open market goes up, the borrowers will continue to pay their fixed rate. In a volatile economy or a period of unusually low interest rates, this can be a definite advantage.
This loan also has a disadvantage, which is that if interest rates go down, the borrower can't take advantage of this. Some borrowers may opt to finance their loans at a lower rate, paying off the first fixed rate mortgage and embarking on a new loan. Refinancing can take time, however, and it may mean that the borrower misses the window of opportunity.
When people apply for a mortgage, they are usually given several options by the financial institution or mortgage broker, along with estimates of monthly payments. In addition to the standard fixed rate mortgage, which usually comes with either a 15 or a 30 year term, borrowers can also consider interest-only mortgages, and balloon payment mortgages. In an interest only mortgage, for example, the borrower pays only interest during the first term, for low payments, and pays on the interest and the principal in the second term, causing a jump in payment size. This option is sometimes considered by people who intend to refinance or sell before the first term is over.
While evaluating a fixed rate mortgage, borrowers should be sure to ask the bank for disclosures on how much will be paid over the life of the loan, and whether or not there is a prepayment penalty. In a fixed rate mortgage with no prepayment penalty, the borrower can pay over the minimum each month, thereby cutting down on the amount paid over time. With prepayment penalties, borrowers may find such overpayments costly.