What Is a Fixed Interest Rate (FIR)?
A fixed interest rate (FIR) is a constant rate charged on liabilities, such as mortgages or home loans. It can be applied to the entire loan term or for part of the term, but it remains unchanged for a specific period. A mortgage can have several interest rate options, including a fixed rate for a particular portion of the loan term and an adjustable-rate for the remaining balance. These are also known as “hybrids.”
How Does Fixed Interest Rates Work?
A fixed interest rate is appealing to customers who do not want their rates to fluctuate over the life of the loan, potentially increasing interest costs and expanding mortgage payments. Furthermore, this type of mortgage rate avoids the risk associated with a variable or floating interest rate. With VIR, the rate adjusted on a debt obligation can change depending on standard interest rates, sometimes unexpectedly.
How to Calculate Fixed Interest Charges
Calculating the fixed interest charges on loans is relatively quick and easy. You need to know:
- The interest rate
- The loan amount
- The loan payment period
Suppose you acquire a US $ 30,000 debt consolidation loan that will be repaid for 60 months at a 5% interest rate. Your estimated monthly installment is $ 566, and the total interest would be $ 3,968.22. That means you don’t return funds early by expanding your monthly repayments or making lump-sum settlements towards the principal balance.
Additionally, assume you get $ 300,000 on a 3.5% mortgage for 30 years. Your monthly payments will be $ 1,347, and the total cost of your mortgage, including interest, would become $ 484,968.
Variable vs. Fixed Interest Rates
Variable interest rates on ARM’s (adjustable-rate mortgages) change periodically. Borrowers typically receive an introductory interest for a specific period, primarily for one, three, or five years. After that, the mortgage rates are adjusted in line with customers’ demands and requirements. These adjustments don’t occur with fixed-rate mortgages, which are not designated as hybrid loans.
In our example, the bank offers borrowers an initial rate of 3.5% on a $ 300,000 mortgage for 30 years with the 5/1 hybrid ARM. Your monthly payments will be around $ 1,347 for the first five years of the home loan. However, these payments will vary as the mortgage rate is based on the interest rates set by the Federal Reserve or other standards.
If the mortgage rate is adjusted to 6%, the borrower’s monthly payment will increase by $452 to $1,799, which can be tough to manage. However, monthly payments will drop to $ 1,265 if the rate changes to 3%.
On the other hand, if the interest rate were set at 3.5%, the borrower would fulfill the same payment of $ 1,347 per month for thirty years.
Monthly bills may change as property taxes or personal insurance premiums fluctuate, but your mortgage installments remain the same.
Fixed Interest Rate: Advantages & Disadvantages
A fixed interest rate can present both benefits and drawbacks to the borrower. Therefore, the joint consideration of the pros and cons can help you decide which loan product to choose: fixed or variable interest rates.
Fixed interest rates provide predictability in the sense that your monthly loan payments remain the same throughout the entire loan term.
ii) Lower-interest rates
When interest rates are reduced significantly, fixed-rate loan products may become a winning option for customers.
iii) Calculate costs
The fixed interest rate on a mortgage or credit line makes it easier to estimate the lifetime costs of borrowing as the rate doesn’t fluctuate during this period.
i) Larger than adjustable prices
Depending on the general interest rate environment, a fixed-rate loan may have a higher interest rate than an adjustable-rate loan.
ii) Declining interest rates
If interest rates decrease, you might be locked into the mortgage with higher rates while the variable-rate loan will meet your benchmark rate.
Refinancing this fixed-rate mortgage into a variable-rate loan can save money when interest rates decrease, but it might be time-consuming, and closing costs can be high.
The Bottom Line
Fixed interest rate mortgages are typically higher than variable rates. Variable or adjustable-rate loans often provide lower initial costs than fixed-rate mortgages. Homebuyers are more likely to choose a fixed rate during this time—when locking in a mortgage is particularly beneficial.