A Fixed Rate
Mortgage (FRM) is a mortgage loan first developed by the Federal Housing
Administration (FHA) where the interest rate on the note remains the same
through the term of the loan, as opposed to loans where the interest rate
may adjust or float. Other forms of mortgage loan include interest only
mortgage, graduated payment mortgage, variable rate (including adjustable
rate mortgages and tracker mortgages) , negative amortization mortgage, and
balloon payment mortgage. The fixed monthly payment for a fixed rate
mortgage is the amount paid by the borrower every month that ensures that
the loan is paid off in full with interest at the end of its term.
Please note that each of the loan types above except for a straight
adjustable rate mortgage can have a period of the loan for which a fixed
rate may apply. A 'Balloon Payment' mortgage, for example, can have a fixed
rate for the term of the loan followed by the ending balloon payment.
Terminology may differ from country to country: loans for which the rate is
fixed for less than the life of the loan may be called hybrid adjustable
rate mortgages (in the United States).
This payment amount is independent of the additional costs on a home
sometimes handled in escrow, such as property taxes and property insurance.
Consequently, payments made by the borrower may change over time with the
changing escrow amount, but the payments handling the principal and interest
on the loan will remain the same. Fixed rate mortgages are characterized by
their interest rate (including compounding frequency, amount of loan, and
term of the mortgage). With these three values, the calculation of the
monthly payment can then be done.
Fixed rate mortgages are often referred to as 'plain vanilla' mortgage
products for their ease of comprehension among borrowers, lacking many of
the dangerous features that can come about ARMs or floating-rate mortgages
with fixed 'teaser rates'.
Fixed rate mortgages are the
most classic form of loan for home and product purchasing in the United
States. The most common terms are 15-year and 30-year mortgages, but shorter
terms are available, and 40-year and 50-year mortgages are now available
(common in areas with high priced housing, where even a 30-year term leaves
the mortgage amount out of reach of the average family).
Outside the United States, fixed-rate mortgages are less popular, and in
some countries, true fixed-rate mortgages are not available except for
shorter-term loans. For example, in Canada the longest term for which a
mortgage rate can be fixed is typically no more than ten years, while
mortgage maturities are commonly 25 years.
mortgages are usually more expensive than adjustable rate mortgages. Due to
the inherent interest rate risk, long-term fixed rate loans will tend to be
at a higher interest rate than short-term loans. The relationship between
interest rates for short and long-term loans is represented by the yield
curve, which generally slopes upward (longer terms are more expensive). The
opposite circumstance is known as an inverted yield curve and occurs less
The fact that a fixed rate
mortgage has a higher starting interest rate does not indicate that this is
a worse form of borrowing compared to the adjustable rate mortgages. If
interest rates rise, the ARM cost will be higher while the FRM will remain
the same. In effect, the lender has agreed to take the interest rate risk on
a fixed rate loan. Some studies have shown that the majority of borrowers
with adjustable rate mortgages save money in the long term, but that some
borrowers pay more. The price of potentially saving money, in other words,
is balanced by the risk of potentially higher costs. In each case, a choice
would need to be made based upon the loan term, the current interest rate,
and the likelihood that the rate will increase or decrease during the life
of the loan.
In the United
States, fixed rate mortgages, like other types of mortgage, may offer the
ability to prepay principal (or capital) early without penalty. Early
payments of part of the principal will reduce the total cost of the loan
(total interest paid), and will shorten the amount of time needed to pay off
the loan. Early payoff of the entire loan amount through refinancing is
sometimes done when interest rates drop significantly.
Some mortgages may offer a lower interest rate in exchange for the borrower
accepting a prepayment penalty.