When a borrower takes out a loan with a lender under a fixed, rather than floating or variable, rate of interest, the resulting monthly payment is called a fixed-rate payment. Fixed-rate payments most commonly refer to mortgage payments, although the term applies to any installment loan with a fixed interest rate. Under a fixed-rate loan, all payments are of equal amounts until the entire balance, including principal and accrued interest, are paid in full. Interest rates stay constant throughout the life of the loan, whether the loan is a mortgage, a car loan, or some other form of installment loan.
Mortgages are the most common loans to have a fixed-rate payment, known simply as a fixed-rate mortgage. Borrowers establishing a mortgage typically have a choice between a fixed-rate payment or a floating-rate payment, also known as an adjustable rate mortgage or ARM. With a fixed-rate mortgage, the borrower can have a more stable budget through predictable payments over the life of the mortgage. Alternatively, adjustable rate mortgages are subject to periodic changes in payment amounts, owing to changing interest rates. Loan terms regarding the length of a loan remain the same, regardless of the method chosen for calculating interest.
Depending on anticipated changes in interest rates, a fixed-rate payment loan can be beneficial, especially if interest rates are expected to rise in the near future. Choosing a fixed-rate mortgage allows the borrower to lock in low interest rates for the next 15 years or more. Should interest rates drop, however, a fixed-rate mortgage can be less than ideal. As such, whether a fixed-rate payment is better depends on current economic conditions. Arguments comparing the benefits of fixed-rate payments versus the benefits of floating or adjustable-rate payments are a common area of contention among bankers and financial experts.
Calculating the fixed-rate payment for a particular loan involves a complex formula. Variables for the formula include the interest rate per period, the number of periods, and the total amount of the principal borrowed. Looking at the mathematical equation for calculating fixed-rate payments, interest is denoted as R, periods are denoted by N, and total principal is denoted as simply Loan. Annual interest rate percentages are divided by the number of payment periods in a year to get R, while the total number of payment periods over the life of the loan are multiplied to get N. Payments equal R divided by 1-(1+R) to the negative Nth power, which is then multiplied by Loan.
