I don’t think it’s hard to understand why a Fixed Rate Mortgage has been the most popular type for decades – most people like stability, and that’s exactly what they get with this kind of mortgage: the Interest Rate is fixed throughout the life of the loan; the monthly payments are fixed, too, if you want them this way. There is nothing tricky or unexpected about this mortgage program. The Interest Rate may be higher than with an Adjustable Rate Mortgage, but you can be absolutely sure, that no matter what, it will not go any higher.
So it is a sound steady payment plan, but is it good for you?
Let’s see into the mechanism, which provides this stability.
Your monthly payment consists of two parts: repaying the Principal and paying the Interest. The amount of the Interest part is calculated as a percentage of the remaining Principal (the balance) of the day. So, every time you pay some of the Principal off (with your monthly payment or some extra payment), the balance becomes smaller, which means that the next Interest payment will be the same percentage but of a lower amount. This Fixed Principal scheme suggests that the initial monthly payments are considerably higher than the later ones. Sometimes way too high. So lenders usually use special formulas to “level” the payments. In short, they pre-calculate the described above payments and then distribute them evenly throughout the term of the mortgage. The formula, however, retains the proportional correlation of Principal and Interest in the period payments. The initial payments pay mostly the Interest, and the later ones repay most of the Principal. For you as a borrower it does not make any difference, because you have a fixed amount to pay every month, no matter how the lender subdivides it.
The most popular terms of a Fixed Rate Mortgage are 15 and 30 years, but plans for 10, 20, 25 or even 40 years are widely available. Use a calculator and professional advice to estimate the financial burden each term is to bring upon you. In general, the shorter the term, the lower the overall cost of the loan, as you save quite a lot on the Interest payments. Even though the Interest Rate on a shorter term mortgage is usually higher, the total amount paid as Interest on, say, a 30-year mortgage gets cut down to around a half of it or even less, if the same amount is borrowed for a term of 15 years. The period payments are higher, though, as the Principal part of each payment has to be higher to pay the debt off within a shorter period of time.
Nowadays Fixed Rate Mortgages account for about 75% of all the mortgage products sold!
