How does a fixed-rate mortgage work?

Fixed-rate mortgages might cost more upfront compared to adjustable-rate mortgages (ARM). However, they also offer predictability that can be appealing compared to the fluctuation that can come with an ARM.

If you’re wondering what a fixed-rate mortgage is and whether it’s the right option for you, here’s what you should know.

What is a fixed-rate mortgage?

A fixed-rate mortgage is a type of home loan that comes with a fixed interest rate that won’t change throughout your repayment period — meaning the amount you pay toward principal and interest each month won’t ever change.

This predictability tends to make fixed-rate mortgages more popular compared to ARMs, which have variable rates that can fluctuate with market conditions.

How it works

With a fixed-rate mortgage, your interest rate will remain the same for the life of the loan. Your rate will be set when you’re approved for the loan based on a variety of considerations, including your credit, loan term, down payment amount and other factors.

The lender will use this interest rate as well as your loan amount and repayment term to amortize the loan. This determines how much you’ll pay toward your principal balance and toward interest each month before reaching a zero balance at the end of your term. 

Types of fixed-rate mortgage loans

There are several types of fixed-rate mortgages available, including:

• Conventional loans: These are mortgages that aren’t part of a government program, including conforming loans and jumbo (or non-conforming) loans. Conventional loans are the most common type of mortgage, though they don’t offer the benefits of government-backed loans.
• FHA loans: These loans are backed by the Federal Housing Administration (FHA) and offer low down payment requirements, low closing costs and easier qualification requirements compared to conventional mortgages.
• USDA loans: Backed by the U.S. Department of Agriculture (USDA), these loans are available to low- and very-low-income borrowers looking to buy a home in eligible rural areas.
• VA loans: These loans are backed by the Department of Veterans Affairs (VA) and are designed for current and former military members as well as their surviving spouses.

Some lenders might also offer additional programs, such as loans geared toward first-time homebuyers or borrowers with less-than-perfect credit.

Fixed-rate mortgage terms

If you’re considering a fixed-rate mortgage, here are several common terms you’ll likely come across:

• APR: Your annual percentage rate (APR) is the cost you’ll pay each year in return for borrowing money, expressed as a percentage. It includes both interest as well as any fees associated with your loan, such as origination fees and mortgage insurance.   
• Amortization: This is the process of paying off a loan’s principal and interest on a fixed schedule of equal installments. On an amortization schedule, a higher portion of your monthly payments will typically go toward interest charges. Later on in your repayment term, a greater amount will go toward your principal balance.
• Closing costs: These are fees associated with your loan’s processing and are usually about 3% to 5% of your loan amount. They include costs like the origination fee, appraisal fee, title fees, discount points and more. 
• Down payment: This is how much you pay toward your home upfront. How much you need to put down depends on the type of loan you get. For example, USDA and VA loans don’t require a down payment while FHA loans require you to put at least 3.5% of the purchase price down. Conventional loan down payments can be as low as 3%, but you’ll have to put a minimum of 20% down to avoid private mortgage insurance (PMI).
• Equity: This is the difference between your home’s worth and what you owe on your mortgage.
• Escrow: A lender will typically set up an escrow account to cover expenses related to the property, such as property taxes and homeowners insurance. Part of your monthly payments will be deposited in this account. Note that while your payment amount including principal and interest will stay the same with a fixed-rate mortgage, your overall mortgage payment can fluctuate over time based on these expenses.
• Fixed interest rate: This type of interest rate remains the same over the life of the loan. 
• PITI: This refers to Principal, Interest, Taxes, and Insurance (PITI), which are the four basic components of a mortgage payment.
• PMI: You’ll usually have to pay for private mortgage insurance if your down payment is lower than 20%. PMI can be removed from the loan once you’ve built 20% equity in your home.
• Repayment term: This is the period of time over which you pay off your loan. Terms for fixed-rate mortgages can range from 10 to 40 years, with 30-year terms being the most common.

How to calculate fixed-rate mortgage costs

The amount you pay in interest on a fixed-rate mortgage loan is based on three elements: the loan amount, the interest rate and the repayment term. Mortgage lenders will provide you with an amortization schedule, which shows your monthly payment and how much of it goes toward interest each month.

You’ll also be given a Total Interest Percentage (TIP) disclosure. This will illustrate the total amount of interest you’ll pay over the life of the loan compared to your original loan amount. Additionally, the TIP will show your total interest percentage, which is the sum of all your interest payments divided by the total loan amount.

Calculating the monthly payment on an amortized, fixed-rate loan is complicated — but if you want to try it on your own, use the following formula. Note that the interest rate per period is the rate divided by 12 months.

Payment amount = Loan amount (interest rate per period (1 + interest rate per period) ^ total number of payments ) / ( ( 1 + interest rate per period ) ^ total number of payments – 1)

Tip: You can also use our home affordability calculator to see what your total costs — including the monthly payments and amortization schedule — could look like on a fixed-rate mortgage.

Example of calculating a fixed-rate mortgage payment

Say you’re looking at a $400,000 fixed-rate mortgage with a 6% interest rate and 30-year term. To prepare to use the formula above, we’d first divide the annualized interest rate by 12 (0.06 / 12 = 0.005), and break the term into months (36 x 12 = 360). Then we’d calculate as follows:

400,000 (0.005 (1 + 0.005) ^ 360 ) / ( ( 1 + 0.005 ) ^ 360 – 1) = $2,398.20

Remember that the payment amount you get from this formula only includes principal and interest. To estimate property taxes and insurance premiums, you’ll need to consult with your loan officer or mortgage broker.

Fixed rate vs. adjustable rate: What’s the difference?

When getting a mortgage, you can choose between a fixed interest rate and an adjustable interest rate. 

Fixed rates

A fixed rate on a mortgage will stay the same throughout the life of the loan regardless of the housing market and economy. This means your monthly payments will be predictable outside of possible changes to additional expenses like taxes and insurance. 

Adjustable rates

An adjustable rate (also known as a variable rate) can fluctuate over time with market conditions. Typically, an ARM will start with a fixed-rate period ranging from three to 10 years. During this time, your interest rate won’t change. 

On top of this fixed-rate period, “an adjustable-rate mortgage will (traditionally) have a lower interest rate at the time of purchase,” says Patricia Maguire-Feltch, a national sales executive at Chase Home Lending. 

However, once this initial period ends, your rate and payment could readjust every quarter, year, three years or five years, depending on the terms of your loan. This means your rate and payment could go up or down, which can be risky.

“It’s best to go with an adjustable-rate mortgage when you know you won’t be in the home for a long period of time,” says Maguire-Feltch.

If you don’t plan on staying in the home for an extended time, you can avoid having your rate fluctuate on an ARM. You could also consider refinancing your loan before the fixed period ends if you can take advantage of better terms.

Pros and cons of a fixed-rate mortgage

While fixed-rate mortgage loans are the most popular type of home loan, it’s important to consider their advantages and drawbacks before you pull the trigger and apply. Here are some of the pros and cons to keep in mind:

Pros

• Predictability: Because the interest rate never changes, the only guesswork about what your monthly payment could look like one, five or 10 years down the road is related to your property taxes and insurance premiums. This certainty can provide peace of mind for risk-averse borrowers.
• Easier to budget: Not having to worry about your mortgage payment changing drastically over time can make it easier to budget for other financial goals, such as saving for retirement or paying off high-interest debt.
• Could be less expensive in the long run: If you’re planning on staying in your home for the long haul, you don’t have to worry about your monthly payments potentially rising if the market changes. This means you might save money compared to what you’d pay with an ARM.

Cons

• More expensive initially: Fixed rates on mortgages tend to start out higher compared to adjustable rates. If you don’t plan to stay in your home for more than a few years, you might end up paying more with a fixed rate than you would with an ARM.
• Could pay more in interest over time: With an ARM, your interest rate can go up or down depending on market conditions. But if you have a fixed-rate loan and interest rates go down over time, the only way to take advantage of lower costs is to refinance your loan, which can be costly.

When should you choose a fixed-rate mortgage?

While a fixed-rate mortgage is a good choice in some cases, it isn’t the right option for everyone. Here are some situations where picking a fixed-rate mortgage could make sense:

• Interest rates are currently low, and you want to lock in a low rate.
• You plan to stay in the home for more than five years.
• You prefer the stability and predictability of a fixed-rate loan.
• Your budget is tight and can’t accommodate a potentially higher monthly payment in the future.

Ultimately, be sure to consider your financial situation and plans for the future to determine the best option for you.

Frequently asked questions (FAQs)