A fixed rate loan refers to a loan that maintains the same interest rate over the loan’s life. Fixed rate loans are common for car loans, home equity loans and mortgages. To calculate a fixed rate loan’s monthly payment, you need to know the amount you are borrowing, the annual interest rate and the duration for loan repayment.
Fixed rate home loans have conventionally been related with rigid conditions. However, with flexible new products on offer, and relatively low interest rates, fixed rate loans are becoming more and more popular. Most fixed rate loans allow additional repayments and include redraw facilities.
A fixed rate loan can be appropriate if you intend to keenly budget your repayment. Knowing the exact amount you need to repay enables you to plan accordingly with a degree of security and certainty. However, some fixed rate loans will charge you for early repayment. This means that if your financial situation improves, you will often be required to either pay a fee, or retain the loan for the original period and pay the full interest amount.
Advantages and Disadvantages of Fixed Rate Mortgage Loans
Fixed rate loans have become popular due to various reasons. The most obvious is that they allow borrowers to pay off their loan by making small, predictable payments over a lengthy period of time. Since interest rates do not change, borrowers are protected from sudden increases in monthly payment if interest rates rise.
Another advantage of fixed rate loans is that they are easy to understand. Whereas some loan types include shifting interest rates and complicated payment schedules, fixed rate loans have much less complex stipulations and payment schedules. The loan’s basic elements, principal (amount borrowed) and interest (premium paid to the lender), are repaid in form of monthly payments.
When you know how much the monthly payments will be, you have a very good idea of the loan’s effect on your monthly finances. Many fixed rate loans also allow borrowers to give extra payments so as to reduce loan’s term or to make lump sum payments to clear the loan earlier without prepayment penalties.
One of the main disadvantages of fixed rate loans is that, if interest rates drop, the loan’s interest rate does not change, and neither does the monthly payment. To lower the interest rate and monthly payment, you will have to refinance the loan, which can be very costly.
Types of Fixed Rate Loans
Interest-Only Fixed Rate Mortgage Loans
If you go for an interest-only choice of a fixed rate loan, the loan term is divided into two periods. In the first period, the monthly payment is lower since you pay interest only and no principal. During the second period, you pay both. For instance, on a 15-year interest-only fixed rate mortgage, you may make interest-only payments for the initial 5 years, and then pay both interest and principal for the remaining 10 years. The actual loan principal will be repaid in the second period.
While they may be an appropriate for particular borrowers, interest-only loans are not for everyone. They are suitable for borrowers who are well aware that their payments will rise considerably when interest and principal payments begin. They are also suitable for borrowers who can qualify for this kind of loan at the fully amortized, fully indexed rate. Do not get into the trap of thinking that your financial situation will be different in the future. If you can’t afford the fully amortized rate at first, don’t gamble with your future. Instead, choose a mortgage which you know you can afford.
Biweekly Fixed Rate Mortgage Loans
These are loans where payments are set up differently. Rather than paying your mortgage monthly, you pay half the monthly payment every two weeks, which is equal to 26 payments a year. The biweekly mortgage enables you to pay to pay off your mortgage faster since you are making an equivalent of one additional monthly payment each year of the loan.
Biweekly mortgages are not offered by all lenders and are not for all borrowers. They require discipline because an extra payment is made every month.
When you begin paying off your loan, some lenders will give you the option of switching to a biweekly mortgage so as to save money on interest payments. You need to be aware that many mortgages allow you to make extra payments of principal any time without paying a fee.
When To Choose a Fixed Rate Mortgage Loan
Borrowers have the option of taking a loan with a variable or fixed interest rate, or a split rate – a combination of both. A variable rate loan is a loan where the interest rate charged changes as market interest rates fluctuate. As a result, the payments also vary. Variable rate loans usually offer flexibility and options, but can be risky in a market where interest rates are continually rising. When taking out variable rate loans, it is important to budget and plan for interest rate hikes, and ensure that you are able to fulfill your repayment obligations when rates rise.
Experts say that fixed loans are a preferable option if interest rates are expected to rise in the medium to long term. However, the disadvantage is that the benefit achieved may not be sufficient to counter the fees you would pay to change from a variable to a fixed rate loan. The best advice is to look at your own financial situation and only think about a change if the fees involved in changing are outweighed by savings benefits.
Other experts suggest that fixed rates hardly ever fall below the normal variable rate for long periods, and when they do, it would be a good idea to fix a part of your loan. You do not have to fix your whole loan, but you can divide the loan between variable and fixed rates with a split rate loan. Such a loan enables you to divide your loan amount between variable and fixed interest rates. This means that in spite of the economic circumstances, your loan will partly suited to it. However, this also means that you are unlikely to get the full benefits of either option.
Ultimately, your loan choice should be determined by your own financial priorities and your situation. It is difficult, even for experts, to predict which way interest rates will move in the long term. Your choice should be made with made in light of your own financial goals, taking into account your income stream and need for flexibility and security.