Fixed Rate Mortgages
By: Kirk Haverkamp
Updated and reviewed: Jul 9, 2013
Choosing a mortgage that fits your budget and lifestyle means choosing the right type of mortgage rate. Over the years, there have been as wide a variety of mortgages as there are flavors of ice cream. If you choose the right one for you, you can find one that’s just as sweet.
The easiest and most vanilla of all mortgages is the fixed-rate mortgage (FRM), where the interest rate remains the same for the life of the loan. The rate is determined at closing, and your monthly mortgage payments remain the same throughout the term of the loan. The most common fixed-rate mortgages have either a 15- or 30-year duration, and account for 75 percent of all home loans.
The alternative to a fixed-rate loan is an adjustable-rate mortgage (ARM), which offers an interest rate that fluctuates based on current market conditions. The most common reason someone would choose an ARM over a fixed-rate loan is because it offers a lower interest rate for the first few years of the loan. The problem with an adjustable rate though, is that the rate eventually starts changing, meaning that your mortgage is unpredictable and harder to budget for over the long term.
Get a low rate - and keep it
When interest rates are low, the fixed-rate mortgage is an easy choice. If your income is stable or increasing, and if you plan to own your home for 10 years or more, there’s probably no better deal available. A thrifty family, who purchases their dream home and pays off their 30-year fixed-rate mortgage while raising 2.5 kids and a dog, will likely enjoying a comfortable retirement after selling their home and moving to Florida.
During the past several years, fixed-rate mortgages have been at historic lows. People have been locking in 30-year rates below 4 percent, and will pay that rate for as long as they keep their mortgages.
By comparison, rates held in the 7 to 9 percent range throughout the 1990s and early 2000s. Before that, Americans suffered under the strain of double-digit interest rates for nearly a decade during the 1980s, topping 18 percent at one point. You can see why people who bought homes during those years are constantly encouraging their friends and family to take advantage of the opportunity to get a fixed-rate mortgage, or refinance into one, when interest rates are as low as they are now.
Rate Development (15 Year & 30 Year Fixed Mortgage Rates)
Last Updated: December 10, 2013
Average rates for 15 and 30 year fixed as well as 5/1 ARM for the past three months.
Fixed versus adjustable rate
With an adjustable-rate loan, you start out with a fixed rate for several years, then the loan resets to a new rate based on current market conditions and continues to do so periodically from then on. The new interest rate is pegged to a particular economic indicator, such as the Constant Maturity Index (CMI), treasury bills, the prime rate, or the London Interbank Offered Rate (LIBOR), as specified in the loan agreement.
The terms of individual ARMs can vary widely. Some may feature unusually low introductory rates for an initial period of three, five, or 10 years, but then reset to a higher rate than ARMs that don't start out as low. A key thing to look out for when comparing ARMs is how much the rate can rise once it begins to reset.
Variable-rate mortgages are great for buyers who don't expect to remain in the home a long time, perhaps because they plan on upgrading in a few years, so they get the benefit of a lower rate while they own the home. They also appeal to young couples just starting out who expect to see their income grow quickly, because an ARM can reduce their current financial burden. However, they can easily get into trouble if rates go up and their family income falls.
The biggest challenge with ARMs is that they can be unpredictable, so it’s hard to create a long-term financial plan. Fixed-rate loans don’t change, and provide stability.
Advantages of fixed-rate loans
While they may cost more in the early years, fixed-rates loans have numerous advantages.
- They are simple and easy to understand compared to ARMs. You don’t have to worry about your interest rate changing, how the rate is calculated, how the payments are structured, or if the loan can go into negative amortization.
- They offer security for buyers, and are appropriate for first-time homeowners.
- They are well-suited to people who like to be able to predict what their monthly expenses are going to be, and for those who wish to keep their homes for a long time.
- Fixed-rate mortgages offer protection from inflation. With inflation, prices go up and the value of your dollar is reduced. But your mortgage payment doesn’t change with a FRM, so when your dollars drop in value it means you’re paying less for your mortgage in real terms.
- When interest rates are low, you can sometimes make an interesting financial move by prepaying principal on a fixed-rate mortgage with a higher rate. For example, if you’re paying 5 percent on a fixed-rate mortgage at a time when CDs and savings accounts are paying only 1 or 2 percent, you’d get a better return on your money by paying down your mortgage than you would by investing in CDs or savings. Paying down the mortgage is just like getting a 5 percent rate of return, only it’s in interest saved rather than paid out to you.
Disadvantages of fixed-rate mortgages
Fixed-rate mortgages are not all peaches and cream. There are some disadvantages when compared to other types of loans.
- Fixed-rate mortgages generally charge higher rates of interest than ARMs over the short-term. Of course, if interest rates go up over the years, an ARM will likely adjust to a rate much higher than that of a comparable FRM.
- Fixed-rate mortgages usually have higher monthly payments than a comparable adjustable-rate loan during the first years of the mortgage.
- They offer less flexibility than ARMs.
- Because interest rates on fixed-rate loans tend to be higher than ARMs, with a higher monthly payment - at least initially - you may be limited to a smaller mortgage than you could qualify for with an adjustable-rate mortgage. However, certain changes to mortgage regulations taking effect in 2014 will reduce some of this advantage for ARMs.
Choosing the right mortgage
How do you decide which mortgage type works best for you?
While it’s impossible to see into a crystal ball, it’s important to have some sense of where you’re going in your life. If you intend to be in your home for only a short time, like three or five years, an adjustable-rate mortgage may be better for you. If you intend to be in your home for 10 years or more, you will be able to take advantage of the long-term benefits that a FRM offers.
Some people choose to take advantage of an ARM's initial low rate and then refinance when the rate adjusts. This can be an effective strategy. However, if home values fall, as they did when the mortgage crisis broke out, you may be unable to refinance and trapped with a higher rate. During the downturn, this is what ultimately drove many borrowers into foreclosure.
ARMs can also be a good choice for people with an irregular source of income, such as business owners or those working on commission. Since they're not getting a steady flow of cash, an ARM's smaller monthly payments can make it easier to manage their monthly outlays. Then when they receive a large chunk of cash, they make an additional payment to reduce their mortgage principal. Many high-value homes are financed this way.
The final factor to consider is how much risk you can tolerate. If you’re the type of person who stays up late at nights worrying about money, an ARM is not right for you. Many people find more peace of mind with a fixed-rate mortgage, because they know what tomorrow’s payment will be.
Getting the best fixed-mortgage rate
No matter what the economy is going through at any given moment, there are things you can do to make sure that you get the best rate available. In the long run, the lower the rate, the more you will ultimately save.
- Diligently maintain a good credit crating. The higher your credit score, the better your rate will be. Lenders give the best rates to people with a FICO credit score over 760. In order to achieve this, you’ll need to pay your bills on time – always – and keep your debt-to-available credit ratio relatively low. Review a copy of your credit reports, which you can get for free once a year at www.annualcreditreport.com, and make sure that there aren’t any errors regarding your payment history. If you find any, take steps to correct them immediately, and make sure the changes are made before you apply for your mortgage.
- Have 20 percent in cash to use as a down payment. You’ll get the best mortgage rates if you can make a down payment of at least 20 percent of the purchase price of the home. If you make a smaller down payment, you'll not only get a higher rate but will have to pay for mortgage insurance as well, which further drives up your costs.
- Avoid jumbo loans. A jumbo loan is one that is higher than the limits for a “conforming” loan backed by Fannie Mae or Freddie Mac. The range where a conventional loan ends and a jumbo begins is between $417,000 and $625,500, depending on local home values (higher limits apply outside the lower 48 U.S. states). If you're buying a home priced higher than the jumbo limits in that area, you can limit your interest costs by taking out a conforming loan for the jumbo limit, then a second "piggyback" loan for the remainder.
- Pay points. Points are a form of prepaid interest, with each equal to 1 percent of the loan amount. By paying them, you can lower your mortgage rate, usually by one-eighth to one-quarter of a percent per point. They can be a good investment if you plan to stay in the home a long time.
- Don’t be a debtor. Lenders will do a thorough analysis of your financial situation. If you have a lot of debt relative to your income, you will look more like a high-risk borrower and not like an appealing candidate for a fixed-rate loan.
Fixed-rate mortgage documents
The application process is pretty simple, but it’s best to be prepared. Once you decide which lender you want to use, they will provide you with an application form. In addition to the application fee, you’ll need the following items:
- Copies of bank statements for several months, and the account numbers for any other bank accounts you own.
- Proof of income, which can be in the form of pay stubs.
- Self-employed individuals will need to provide two to three years of tax returns to show proof of income.
- Evidence of your current mortgage or rental payments in the form of cancelled checks.
- Verification of your down payment. This can be a statement from the bank where you’re holding the funds.
Locking in your rate
Once you find the terms and interest rate that are the most favorable, you’ll want to make sure that they'll still be available when you close. Because interest rates change daily, it’s possible that your rate can go up. (Then again, they could go down as well.) But if you like what you see, it’s a good idea to ask the bank to lock in the rate, which means the rate offer will be good for a certain length of time, usually 30 to 60 days.
If you choose to lock in your rate, make sure you get it in writing. An oral commitment from a loan officer will not do the trick. Some lenders may charge a fee for the privilege of locking in a rate, and may not refund it if the loan does not close within the specified period.
The lock-in period should give you and the bank time to get all approvals necessary to close on the home and/or loan. If you don’t close within the specified time frame, your lock will expire and you will likely have to renegotiate your rate and points based on the prevailing interest rates at that time. will most likely lose the interest rate and points, unless they are still currently available.
It’s not enough to know just the interest rate and the term of the loan – you also need to know how much the loan will cost. The bank will give you a Good Faith Estimate (GFE) within three days of your application for the loan, which will show you an estimate of your closing expenses. However, it is only an “estimate,” and the costs could significantly change by the time you actually hit the closing table. Here are some tips to determine your closing costs.
- Points. If you want to lower your interest rate, you may have the option to pay points, which are fees paid to the lender to buy down your rate. Each point costs 1 percent of the mortgage amount. The more points you pay, the lower your rate will be. Always ask the lender to quote you the actual dollar amount as opposed to the number of points, so you can clearly understand what you’ll be paying. You’ll be required to pay your points at closing.
- Application and Underwriting fee. The cost of processing your loan. It should also include the costs of your credit report.
- Appraisal fee. In order to determine the value of your home, the bank will order an appraisal. You’ll be required to pay the fee at closing.
- Title insurance. With every mortgage, you will need to pay for a title search and insurance. The title company will do research to make sure that there are no liens on your property, and will insure the lender in case there are any errors.
- Other expenses. Additional costs that you may be required to pay for, which can include recording fees, tax service, pest inspection, flood certification, and a survey, if required.
- Attorney’s Fees. Not only will you be required to pay for your attorney, but the bank will generally likely charge you for theirs, as well.
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|30 yr fixed||5.13|
|15 yr fixed||4.09|
Rates may contain points
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