Understanding the Pros and Cons of Fixed-Rate Mortgages

May 01, 2024
Knowledge Bank | Personal

For most people, homeownership is an important milestone that signifies financial stability and success. However, the decision to buy a home comes with many considerations, including which type of mortgage you should apply for. Among the various mortgage options available, the fixed-rate mortgage is widely popular and preferred by many homebuyers.

In fact, according to Bankrate, roughly 89% of U.S. mortgages in 2021 were fixed rate. With a figure like that, it begs the question “Is there any reason not to choose a fixed-rate mortgage for my home?”

To fully understand a fixed-rate mortgage it’s helpful to compare the pros and cons. Let’s review the advantages and disadvantages to help you make an informed home-buying decision that aligns with your financial goals:

  1. Pro: Stability and Predictability
  2. Pro: Protection Against Rising Interest Rates
  3. Pro: Simplicity and Ease of Planning
  4. Con: Potentially Higher Initial Interest Rates
  5. Con: Lack of Flexibility

Defined: What is a Fixed-Rate Mortgage?

As the name suggests, a fixed-rate mortgage is a home loan with an interest rate that remains constant throughout the loan term. This means that your monthly principal and interest payments will not change throughout the course of the loan. However, if homeowners’ insurance and property taxes are also included as part of your monthly mortgage payment, it’s important to remember that those can fluctuate as a result of changes in coverage or municipal tax rates.

Pros of Fixed-Rate Mortgages

  • Stability and Predictability
    One of the major advantages of a fixed-rate mortgage is the stability it offers. With a fixed interest rate, you can accurately plan your finances as your monthly mortgage payment remains the same over the entire loan term. This predictability allows you to budget effectively, providing peace of mind during life’s economic changes.
  • Protection Against Rising Interest Rates
    Another significant advantage of a fixed-rate mortgage is that it shields you from the impact of rising interest rates. Once you lock in a favorable rate at the time of mortgage origination, you are safeguarded against any future increases in interest rates. This protection enables you to plan your long-term finances without worrying about fluctuations in mortgage costs.
  • Simplicity and Ease of Planning
    Fixed-rate mortgages are generally straightforward and easy to understand. There are no surprise adjustments or varying rates to decipher, simplifying the planning process for homeowners. This simplicity makes fixed-rate mortgages an attractive option, especially for individuals who prefer a clear and uncomplicated approach to their mortgage payment calculations.

Cons of Fixed-Rate Mortgages

  • Potentially Higher Initial Interest Rates
    One potential drawback of fixed-rate mortgages is their initial interest rates. Often, these rates can be higher compared to the initial rates of adjustable-rate mortgages. Consequently, borrowers may have to pay a slightly higher amount in interest over the early years of their mortgage. However, it is essential to consider the long-term stability and potential interest rate hikes when making this comparison.
  • Lack of Flexibility
    Fixed-rate mortgages offer limited flexibility when it comes to taking advantage of falling interest rates. Unlike adjustable-rate mortgages, where borrowers can benefit from reduced interest rates during the loan term, fixed-rate mortgages would require refinancing to lock in a lower rate. Refinancing entails certain costs and considerations, which may not always be financially viable or practical for homeowners.

What Fixed-Rate and Adjustable-Rate Mortgages Have in Common

Fixed-rate mortgages and adjustable-rate mortgages share common features that are fundamental to the mortgage lending process. Both types of mortgages are used by borrowers to finance the purchase of a home and involve borrowing money from a financial institution, such as a bank or a mortgage lender, with the property serving as collateral for the loan. Additionally, both fixed-rate and adjustable-rate mortgages require borrowers to make regular recurring monthly payments.

Furthermore, fixed-rate mortgages and adjustable-rate mortgages are structured in a way that allows borrowers to repay the loan over a specified period, typically ranging from 10 to 30 years. Both types of mortgages also require borrowers to meet certain eligibility criteria, such as having a stable income, a good credit score, and a sufficient down payment, to qualify for the loan. Additionally, borrowers are subject to the same application and approval processes when applying for either a fixed-rate or adjustable-rate mortgage, which may include providing financial documentation, undergoing a credit check, and obtaining a loan pre-approval.

Comparing Fixed-Rate Mortgages vs. Adjustable-Rate Mortgages

When comparing these two types of home loans, here’s what you really need to know:

  • Fixed-rate mortgages offer more stable payments, but can also mean more interest paid over the lifetime of the loan due to a locked-in interest rate
  • Adjustable-rate mortgages may offer better introductory interest rates as well as the potential for interest rates to drop in the future, but also the potential for interest rates to rise
  • Both require qualifying criteria and credit scores
  • Both are eligible to refinance in the future

How to Know if a Fixed-Rate Mortgage is Right for You?

To know if a fixed-rate mortgage is the right choice for you, it’s helpful to think about what your plans are for the future. Is this next move a permanent one? A fixed-rate mortgage is a popular choice for people planning to stay in their home for a number of years or who value the peace of mind that comes with knowing their mortgage payment will not change.

Additionally, how risk-averse are you? Homebuyers who prioritize financial security and prefer to avoid the risks associated with adjustable-rate mortgages may also find fixed-rate mortgages to be the most appealing option. For borrowers who anticipate interest rates to rise in the future, locking in a fixed interest rate can provide protection against potential rate hikes and offer long-term cost savings.

Making the Right Choice

Understanding the pros and cons of fixed-rate mortgages is crucial when embarking on your homeownership journey. The stability, predictability, and protection against rising interest rates make fixed-rate mortgages an appealing choice for many. However, the potentially higher initial interest rates and lack of flexibility are essential factors to consider. Ultimately, your decision should align with your financial goals and preferences.

Take out the uncertainty by talking to a qualified mortgage professional who can provide you with better understanding and help you move forward with the most suitable mortgage option for your specific circumstances.