Like ice cream, mortgages come in a wide variety of "flavors," or different types. And just like ice cream, the best-selling variety is plain vanilla - the fixed-rate loan.
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Fixed-rate mortgage loans have a lot to recommend them. They're simple. They're easy to understand. Your mortgage rate and monthly payments never change. Yet they still offer enough variety to meet the needs of a broad range of borrowers and budgets.
With the best 30-year fixed mortgage rates running in the mid-3 percent range the past few years, borrowers have been enjoying a great run on the most popular mortgage around. At the same time, 15-year fixed mortgage rates have been bouncing around the high 2/low 3 percent range, offering even better bargains for borrowers looking to pay their loans off in a hurry.
What is a fixed-rate loan?
Just as the name implies, a fixed-rate loan is one where the rate is fixed, or never changes. If you start out with a 30-year fixed mortgage rate of 4 percent today, you'll have that rate locked in for the life of the loan.
The alternative to a fixed-rate mortgage loan is an adjustable-rate loan, or ARM. With an ARM, your mortgage rate fluctuates over time depending on market conditions. You start out with a lower rate initially, but that rate could rise or fall once the rate starts adjusting.
The 30- and 15-year fixed-rate mortgages are by far the most popular type of home loans, accounting for about 75 percent of all U.S. residential mortgages. They're available in other lengths as well, 20- and 10-year fixed-rate mortgages in particular, but lenders will sometimes offer other lengths as well, up to 40 years in some cases.
The shorter your fixed-rate loan, the lower your mortgage rate. So 10-year fixed mortgage rates are lower than those on 15-year loans, which are lower than 20-year rates, which are lower than 30-year fixed mortgage rates.
You pay much less interest with the shorter loans and lower rates, but your monthly payments are higher because you're making larger payments toward your loan principle each month. So you want to choose the type that best fits your personal situation and goals.
Types of fixed-rate mortgages
Just as vanilla ice cream offers different styles such as French, golden and vanilla bean, fixed-rate home loans come in different varieties as well. Some are primarily used for buying a home; others are popular for refinancing. Some are designed for borrowers who want to minimize their down payment, some work better for borrowers with lower credit scores.
Take the various loan terms (time it takes to repay) described above. Someone looking to buy a home would likely be most interested in checking out 30-year fixed mortgage rates, because they'd likely want to minimize their monthly payments in order to make their new home as affordable as possible.
But someone who's looking to refinance a 30-year mortgage they've been paying down for several years may be more interested in a 20- or 15-year fixed-rate mortgage to more closely match the time remaining on their loan. Because 15-year fixed mortgage rates tend to be significantly lower than 30-year rates, you can often shave a few extra years off your remaining loan term with a 15-year refinance without increasing your monthly payment.
Fixed-rate FHA mortgages are often a good choice for borrowers seeking to minimize their down payment or who have lower credit scores. FHA loans allow down payments as small as 3.5 percent and are often less costly for borrowers with credit scores in the 600s (the FHA backs adjustable-rate mortgages as well).
Most U.S. mortgages are backed by either Fannie Mae or Freddie Mac. These usually offer the best 10- to 30-year fixed mortgage rates for borrowers with good credit scores.
If you're a veteran or active duty member of the armed forces, a VA loan is likely your best choice for a home loan. For those eligible, 30-year fixed VA mortgage rates are some of the best on the market, coupled with the fact that no down payment is required in most cases.
If you're looking for a high-end home, you may have to opt for a jumbo loan, which allows you to exceed the borrowing limits on conventional mortgages. Jumbo loans traditionally have been ARMs, but there are lenders who offer fixed-rate jumbos. Mortgage rates on jumbo loans typically run slightly higher than on conventional mortgages.
Fixed-rate loan versus an ARM
As noted above, the alternative to a fixed-rate mortgage loan is an adjustable-rate mortgage, or ARM. The main advantage of fixed-rate home loans is predictability – you know what your interest rate and mortgage payments will be for the life of the loan.
A fixed-rate loan is a particularly good choice when mortgage rates are low, such as they currently are. Even if mortgage rates move higher back toward historic norms, you've still got today's low rates locked in. That also makes them a good choice for borrowers who plan to make the home their permanent dwelling.
Even so, don't automatically dismiss ARMs. Most ARMs start out with a fixed rate over the first 1-10 years before the rate starts to adjust. That makes them an excellent choice for borrowers who don't plan to stay in the home a long time. Since initial rates on ARMs are lower than on fixed-rate loans, a borrower who expects to move in 5-7 years can get an ARM where the initial rate is fixed for at least that long and shave perhaps half a percent off 30-yr fixed mortgage rates.
ARMs also provide versatility, as they're sometimes combined with other features to make them more flexible, such as balloon payments, interest-only phases, negative amortization and the like. However, such options are best suited for financially sophisticated borrowers as they can present significant hazards for the unwary, as happened during the housing bubble.
Advantages and disadvantages of fixed-rate home loans
We've already touched on some of the pros and cons of fixed-rate mortgages. Here's a summary of the main ones.
- Fixed-rate loans are the simplest and most straightforward type of mortgage. You don't have to worry about hidden features that could cause your payments to increase.
- They are predictable, allowing you to budget for them over the long-term.
- They are well-suited for first-time homebuyers who are just learning about mortgages.
- Fixed-rate mortgages are a good choice for people who plan to keep their homes a long time.
- Fixed-rate home loans offer protection from inflation, which can drive up interest rates. Since your payments don't change, inflation also means you're making those payments with inflated dollars, meaning you're paying less for your mortgage in real terms.
- Adjustable-rate mortgages offer lower initial rates and monthly payments than you can get on fixed-rate loans.
- Fixed-rate mortgages offer less flexibility than ARMs and fewer financing options.
- Persons who plan to sell or refinance their home in a few years may be better off with an ARM, as they do not need to lock in a rate long-term.
- If interest rates fall, having a fixed-rate home loan means you're paying an above-market rate for your mortgage, unless you go to the expense of refinancing.
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.
- Shop around. Mortgage rates and terms vary from lender to lender, so if you want to find the best 30-year fixed-mortgage rates, for example, you're going to have to do some digging. Check the ads, go online and ask for quotes from various lenders. You may be surprised by how much they can vary.
- Build and maintain a good credit rating. People with higher credit scores get lower mortgage rates. Pay your bills on time. Keep your credit card balances low – better yet, pay them off every month. Be judicious with other debts like auto loans – don't take on more than you can afford. If you haven't established credit, apply for a credit card and make occasional use of it, paying the balance off in full each time.
- You'll get a lower mortgage rate and avoid paying for mortgage insurance if you can make a down payment of at least 20 percent. A 10 percent down payment will get you a lower down payment than 5 percent on a conventional Fannie/Freddie mortgage. It's not a bad idea to wait to save up a larger down payment, but be aware of the cost of continuing to pay rent during that time or of the risk that mortgage rates may rise.
- Pay for discount points. Points are a form of prepaid interest, each costing 1 percent of the loan amount. Each one you buy reduces your mortgage rate by a certain amount, usually one-eighth to one-quarter of a percent. They can be a good investment if you plan to stay in the home a long time.
- Don't be a debtor. Having too much debt relative to your income will make you look like a high-risk borrower to lenders. Carrying a lot of debt will also lower your credit score.
- If you have weaker credit, consider an FHA fixed-rate loan. Those generally have lower rates for borrowers with credit scores below 700.