A fixed-rate mortgage has a fixed interest rate throughout the duration of repayment. The total interest to be paid on top of the principal amount is determined and known at the time of taking the mortgage. In this case, the home owner is saved from having to contend with changing loan amounts which change with the movement of interest rates.
When choosing the right mortgage, there is always a tradeoff between reward and risk and the between a fixed-rate mortgage and a variable-rate mortgage. Depending on conditions in the market, a variable-rate mortgage always attracts a larger initial payment advantage compared to a fixed-rate mortgage. However, even in such cases, there are always high chances that payments made on a variable-rate mortgage will keep raising with time. With in mind, it is important to first evaluate and measure the risks involved before deciding on whether to take a fixed or variable-rate mortgage.
There are different types of the fixed-rate mortgage depending on the period of repayment of the mortgage. These include:
5-year fixed rate mortgage - In this type of mortgage, a constant interest rate is maintained during the first five years. After the first five years, the mortgage switches to a variable –rate mortgage. The advantage here lies in the fact that the 30-year mortgage attracts lower interest rate during the first five years. The disadvantage is that this interest may rise very quickly after the first five years.
15-year fixed rate mortgage - This is preferred by many people due to the fact that it attracts lower interest rates. It also enables the borrower to settle the principal amount much faster compared to the conventional 30-year mortgage. With a faster repayment period, the borrower is able to build equity faster.
30-year mortgage - This is the cheapest conventional mortgage. Although it attracts higher interest rates, it has much lower monthly premiums because the repayment period is spread out over a long period of time. It is best suited for those people who intend to stay in the home for a long time. Additionally, it may be preferred by low-income families due to lower monthly payments.
The biggest advantage with fixed-rate mortgage is the constant monthly repayment amount. It is very predictable making to arrange the budget. The borrower is saved from the worries of possible higher payments like the case of variable-rate mortgages. One only pays a small portion of the principal every month. This in turn increases the family’s equity.
In fixed-rate mortgage, one can make arrangements to pay the principal amount earlier. Most fixed-rate mortgages do not attract pre-payment penalties. It is also the right choice if you speculate that interest rates may rise in the future due to shake-ups in the economy.
The main disadvantage with fixed-rate mortgage is that fact that it attracts higher interest rates compared to the variable-rate or interest only mortgage. This makes the mortgage very expensive if the interest rates remain constant throughout the whole repayment period.
Another disadvantage is the fact that the borrower pays the principal amount at a very slow rate compared to the variable-rate mortgage. This because the first repayments made over the first few years mainly goes towards paying the interest rates. This can be very inconveniencing for a person who intends to sell the house after five or ten years.