Business, Legal & Accounting Glossary
A fixed-rate mortgage, or FRM, has a fixed interest rate over the duration of the loan. In contrast, the mortgage with a changing interest rate is called an adjustable-rate mortgage, or ARM. The ARM will generally have a lower interest rate than a similar fixed-rate mortgage because the fixed-rate mortgage lacks interest rate risk. The term fixed-rate mortgage is often confused with the term conventional mortgage. Unlike a conventional mortgage, the fixed-rate mortgage does not have to be fully amortizing though this is usually the case. A fixed-rate mortgage can even be a balloon loan. Both the terms fixed-rate mortgage and conventional mortgage are also further confused with the term conforming mortgage. The fixed-rate mortgage can be but is not necessarily conforming.
A mortgage loan that has an interest rate that remains constant throughout the life of the loan, so that the amount you pay each month remains the same over the entire mortgage term, typically 15, 20 or 30 years.
A fixed-rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or “float.” Other forms of mortgage loan include interest-only mortgage, graduated-payment mortgage, adjustable-rate mortgage, negative amortization mortgage, and balloon payment mortgage. Please note that each of the loan types above except for a straight adjustable-rate mortgage can have a period of the loan for which a fixed rate may apply. A Balloon Payment mortgage, for example, can have a fixed rate for the term of the loan followed by the ending balloon payment. Terminology may differ from country to country: loans for which the rate is fixed for less than the life of the loan may be called hybrid adjustable-rate mortgages (in the United States).
This payment amount is independent of the additional costs on a home sometimes handled in escrow, such as property taxes and property insurance. Consequently, payments made by the borrower may change over time with the changing escrow amount, but the payments handling the principal and interest on the loan will remain the same.
Fixed-rate mortgages are characterized by their interest rate (including compounding frequency, amount of loan, and term of the mortgage). With these three values, the calculation of the monthly payment can then be done.
Unlike adjustable-rate mortgages, fixed-rate mortgages are not tied to an index. Instead, the interest rate is set (or “fixed”) in advance to an advertised rate, usually in increments of 1/4 or 1/8 per cent.
Fixed-rate mortgages are the most classic form of loan for home and product purchasing in the United States. The most common terms are 15-year and 30-year mortgages, but shorter terms are available, and 40-year and 50-year mortgages are now available (common in areas with high priced housing, where even a 30-year term leaves the mortgage amount out of reach of the average family).
Outside the United States, fixed-rate mortgages are less popular, and in some countries, true fixed-rate mortgages are not available except for shorter-term loans. For example, in Canada, the longest term for which a mortgage rate can be fixed is typically no more than ten years, while mortgage maturities are commonly 25 years. In Australia, banks are unable to offer fixed rates for terms longer than 15 years due to funding constraints.
Fixed-rate mortgages are usually more expensive than adjustable-rate mortgages. Due to the inherent interest rate risk, long-term fixed-rate loans will tend to be at a higher interest rate than short-term loans. The difference in interest rates between short and long-term loans is known as the yield curve, which generally slopes upward (longer terms are more expensive). The opposite circumstance is known as an inverted yield curve and is relatively infrequent.
The fact that a fixed-rate mortgage has a higher starting interest rate does not indicate that this is a worse form of borrowing compared to the adjustable-rate mortgages. If interest rates rise, the ARM cost will be higher while the FRM will remain the same. In effect, the lender has agreed to take the interest rate risk on a fixed-rate loan. Some studies have shown that the majority of borrowers with adjustable-rate mortgages save money in the long term, but that some borrowers pay more. The price of potentially saving money, in other words, is balanced by the risk of potentially higher costs. In each case, a choice would need to be made based upon the loan term, the current interest rate, and the likelihood that the rate will increase or decrease during the life of the loan.
In the United States, fixed-rate mortgages, like other types of mortgage, may offer the ability to prepay principal (or capital) early without penalty. Early payments of part of the principal will reduce the total cost of the loan (total interest paid) and will shorten the amount of time needed to pay off the loan. Early payoff of the entire loan amount through refinancing is sometimes done when interest rates drop significantly.
Some mortgages may offer a lower interest rate in exchange for the borrower accepting a prepayment penalty.
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This glossary post was last updated: 1st May, 2020 | 2 Views.