Are you looking for a type of loan that can give you consistent payments? Are you tired of having a fluctuating rate? Do you want to save money while interest rates are rising?
If so, you may be looking for a fixed-rate loan. This kind of personal loan can give you predictability when it comes to your payments. And, it can save you money in interest payments.
But, if you’re going to get the right fixed-rate loan, you need to understand how fixed-rate loans work. To do that, just keep reading.
What Is a Fixed Interest Rate?
A fixed interest rate is unchanging, regardless of the current market conditions. This kind of interest rate applies to liability charges like mortgages and personal loans.
Fixed-interest rate loans can apply for the entire term of the loan or just a part of it. But, no matter how long the fixed-interest deal lasts, the interest rate doesn’t change.
By having a fixed rate personal loan, you could negate the risk that comes with long-term loan payments. Because of this, the best time to get a fixed interest rate is during a period of low interest rates.
What Is a Variable Interest Rate?
Unlike a fixed interest rate, variable interest rates do change over time. The change in a variable interest rate mirrors the change in the current market rates.
So, this means that a variable interest rate can be lower or higher than fixed-interest rates. It just depends on what the variable rate for that time is.
Borrowers tend to opt for variable interest rates during times of high interest. This ensures that the borrower can take advantage of lower interest rates when they eventually come around.
What Is a Fixed-Rate Loan?
Just like any other loan, a fixed-rate loan is a tool that someone can use to borrow money against a liability, like a home or a car. Unlike other loans, a fixed-rate loan is one in which the interest rate does not fluctuate over time.
Those who don’t want to deal with changing interest rates find fixed-rate loans more attractive than other kinds of loans. If the interest rate were to fluctuate, borrowers may have to incur higher interest payments and – in turn – higher total payments.
Getting a fixed-rate loan can help borrowers avoid the uncertainty that comes with variable-rate loans. As the name implies, variable-rate loans have a fluctuating interest rate that changes with the current market conditions.
What About Adjustable-Rate Mortgages?
Whether you heard it on television or through an online ad, you’ve likely heard of adjustable-rate mortgages. So, if they aren’t fixed or variable, what does adjustable mean?
Well, adjustable-rate mortgages and all other adjustable-rate loans change periodically. Typically, a borrower with this kind of loan gets an introductory rate for a pre-determined period of time. This could be one year, three years, five years, or some other amount of time.
After that predetermined period of time is over, the interest rate will begin to fluctuate similar to that of a variable-rate loan.
Adjustable-rate mortgages are great for people who think that the market may tank in the short term but do well in the long term. Because the market is difficult to predict, there is a little bit of gambling involved when you’re choosing an adjustable-rate loan or a variable-rate loan.
What Are the Types of Mortgage Loans With Fixed-Rates?
There are three kinds of fixed-rate loans that you can consider if you’re looking to buy a house:
- Adjustable-Rate Mortgage
- Conforming Loans
- FHA Loans
You should consider all of these and make the right choice based on your financial health and the current interest rates.
We’ve already reviewed the basic features of an adjustable-rate mortgage (ARM). These kinds of loans fluctuate after a pre-determined period of time.
You can have a 5/1 adjustable-rate mortgage, a 15-year mortgage, or a 30-year mortgage. Some other lenders may offer other types of loans, but these are the most popular choices.
A 5/1 adjustable-rate mortgage starts with a five-year fixed-rate mortgage. Then, it varies according to the current interest rate.
These kinds of mortgages are popular for people who are planning to sell their home in five years or believe that the interest rates will drop within this amount of time.
A 15-year mortgage has a fixed rate for the entire 15 years of the loan. This kind of loan allows borrowers to pay off more of the principal with each payment that they have. So, you’ll be able to build equity faster.
15-year mortgages have a higher monthly payment, too. So, you may have a risk of defaulting on the loan if your income drops.
A 30-year mortgage is one of the most affordable kinds of mortgage loans. The monthly payment is lower, but you’ll be paying more over time.
This is a great choice for those who are staying in their home for a long period of time.
Conforming loans have a maximum amount that the federal government sets. They’re insured through Freddie Max or Fannie Mae. So, they can be less expensive than non-conforming loans.
The Federal Housing Administration insures and regulates FHA loans. Borrowers may have lower credit scores than available for other loans.
They also have a lower down payment than other kinds of loans.
How Do Fixed Loans Work?
Loans typically have monthly payments attached for the length of the loan. Each payment is calculated by taking the principal payment times the interest rate plus a small percentage of the principal payment.
Principal payments go towards the actual loan amount, while interest payments account for the amount of money that you’re paying to borrow the money from the lender. Because these payments occur over the course of the loan, you always end up paying more back to the lender than you initially borrowed.
As you pay the loan, you’re amortizing it. You may hear of amortization calendars/charts which tell you how much you’re going to be paying over the entire loan term.
You’ll pay off a little bit of the principal each month. So, the amount of interest that you’re paying on the remaining principal will go down, too. And, in turn, more of the monthly payment will go towards the principal as time goes on.
This is why the majority of your beginning payments go towards interest payments. Then, at the end of the loan, the majority of your monthly payments will go towards the principal amount.
What Are the Advantages and Disadvantages of Fixed Interest Rates?
Fixed interest rates usually come out to be higher than adjustable rates and variable rates. This is why loans with adjustable or variable rates tend to give out lower introductory rates. When interest rates are high, adjustable-rate loans and variable-rate loans are more appealing.
However, fixed-rate loans are more appealing during times of low interest rates. During this time, it’s best to lock in the rate before they start to go up again.
Some people are willing to bet that interest rates will soon decrease. These people are more likely to go for variable-rate loans since the total interest payment over the entire course of the loan would be less than other kinds of loans.
However, it’s a risk to make assumptions about the market. So, you have to be willing to take the loss if your prediction turns out wrong.
What Are the Current Interest Rates in My Area?
The Consumer Financial Protection Bureau puts out a list of interest rates. The page updates and refreshes biweekly. And, you can search for your area to see what kind of interest rates you can find right now.
You can also use their tool to input your credit score, down payment, and loan type. This will help you get a better idea about what kind of interest rate you may pay.
You can also compare these rates to the rate that you may get with an adjustable-rate loan.
How Do Lenders Determine Interest Rates?
In most cases, the current interest rate is slightly higher than the 30-year Treasury bond at the time that the lender gives the borrower the loan. Investors buy loans on the secondary market when they want more return than the Treasurys are currently giving. The secondary market also provides a lower-risk opportunity.
Since 1985, interest rates have been declining over time. There have been some fluctuations, but the rates have seen a downward trend overall.
These interest rates have responded like this because the Federal Reserve has been controlling inflation since then. This has led to lower rates on Treasury bonds and – in turn – lower interest rates on loans.
Where Can I Learn More About Fixed-Rate Loans?
Understanding what a fixed-rate loan is is one of the most important steps in obtaining a loan of any kind. You need to understand your options and pick the best one for you right now.
And, there’s always more to learn.
So, you should check out the rest of my blog to learn more about fixed-rate loans and other important financial factors.