What Is a Fixed Interest Rate?

Fixed interest rates are charged on loans and mortgages. It may apply for the entire loan term or part of it, but it stays the same. Mortgages can have a fixed rate for part of the term and an adjustable rate for the rest. These are called hybrids.

Fixed-interest rates work

Borrowers prefer fixed interest rates to avoid fluctuating rates that could increase interest expenses and mortgage payments. A floating or variable interest rate can change unexpectedly based on a benchmark interest rate or index, but this rate avoids that risk.

Borrowers prefer fixed rates when interest rates are low because locking in the rate is beneficial. If interest rates drop, the opportunity cost remains lower than at high rates.

Fixed rates usually exceed adjustable rates. Low introductory rates make flexible or variable-rate loans more appealing than fixed-rate loans at high-interest rates.

According to the Consumer Financial Protection Bureau (CFPB), interest rates vary by location and can change over time. Consumers can compare fixed interest rates with adjustable-rate mortgages (ARMs) by entering their credit score, down payment, and loan type updated biweekly.

Fixed-rate loans have a fixed interest rate. Future budgeting is easier because the borrowers ‘ payments stay the same.

Calculating Fixed Interest Costs

Loan fixed interest costs are easy to calculate. You need only know:

• The loan amount
• An interest rate
• The loan repayment period

Remember that credit scores and income can impact loan rates, regardless of fixed or variable rates.

Online loan calculators can quickly calculate fixed interest rates for personal loans, mortgages, and other credit lines.

Fixed vs. Variable Interest Rates

Variable interest rates on ARMs fluctuate. Borrowers usually get an introductory rate for one, three, or five years. The rate adjusts periodically after that. Non-hybrid fixed-rate loans do.

A bank offers a 3.5% introductory rate on a $300,000, 30-year mortgage with a 5/1 hybrid ARM. The first five years of the loan cost $1,347 per month, but the rate will change based on the Federal Reserve or another benchmark index.

Increasing the rate to 6% would raise the borrower’s monthly payment by $452 to $1,799, which may be challenging to manage. But the monthly payments would fall to $1,265 if the rate dropped to 3%.

If the 3.5% rate were fixed, the borrower would pay $1,347 monthly for 30 years. The monthly bills might vary as property taxes change or the homeowner’s premiums adjust, but the mortgage payment remains the same.

Fixed-rate loans can be counted on, but some uncertainty is associated with variable interest rates.

Advantages and Disadvantages

Fixed interest rates can offer both pros and cons for borrowers. Looking at the advantages and disadvantages can help decide whether to choose a selected- or variable-rate loan product.

Advantages

Fixed interest rates provide consumers with some degree of predictability. This means that your monthly loan or mortgage payments remain the same for the loan’s lifetime. Even if conditions change and rates increase, your rate stays the same. As such, you don’t have to budget for increases in your payments later.

When interest rates are low or near historic lows, a loan with a fixed interest rate can become more attractive. Taking out a loan with adjustable or variable rates probably won’t be a good option, especially since there is a risk that rates may go up in the future.

A fixed interest rate on a mortgage, loan, or line of credit makes it easier to calculate the lifetime cost of borrowing because the rate doesn’t matter. This allows you to budget for other expenses, including vacations or a new car. It also enables you to plan for any savings.

Disadvantages

Fixed interest rates tend to be higher than adjustable rates. Depending on the overall interest rate environment, a loan with a fixed rate may carry a higher interest rate than an adjustable-rate loan.

You’ll want to consider declining rates regarding fixed interest rates. If interest rates fall, you could be locked into a loan with a higher rate, whereas a variable-rate loan would keep pace with its benchmark rate.

Refinancing is another drawback. When you refinance your loan from one fixed-rate product to another of the same type or a variable-rate loan, you could save money when rates drop. However, it can be time-consuming, and closing costs can be high.

Pros

• Offer predictability
• More attractive when interest rates are low
• It is easier to calculate the long-term costs of borrowing

Cons

• It may be higher than adjustable rates
• If rates decline, you may pay more for your loan
• Refinancing to a lower rate can be time-consuming and expensive

Example of Fixed Interest Rate

Let’s look at some examples to show how fixed interest rates work.

Assume you’re taking out a $30,000 debt consolidation loan to be repaid over 60 months at 5% interest. Your estimated monthly payment would be $566, and your total interest would be $3,968.22. This assumes you don’t repay the loan early by increasing your monthly payment amount or making lump-sum payments toward the principal. Here is another example. Say you get a $300,000 30-year mortgage at 3.5%. Your monthly payments would be $1,347, and your total mortgage costs, with interest included, would be $484,968.

How do fixed interest rates work?

Fixed interest rates remain constant throughout the lifetime of the loan. When you borrow from your lender, the interest doesn’t rise or fall but remains the same until your debt is paid off. You risk losing out when interest rates drop, but you won’t be affected if rates rise. With a fixed interest rate on your loan, you know precisely how much you’ll pay each month, so there are no surprises. As such, you can plan and budget for your other expenses accordingly. What’s the difference between fixed and variable interest rates?

Fixed interest rates remain constant throughout the lifetime of the debt. This means they aren’t susceptible to changes in the economy. So, if you have a mortgage with a fixed rate of 6%, it will never change until you pay off the debt. Variable interest rates, on the other hand, are subject to change based on the interest rate environment. When interest rates drop or rise, the rate on your loan will follow suit. So your loan may be cheaper or more expensive, depending on whether rates drop or what’s

What’s the benefit of a fixed-interest loan?

There are a few benefits to a loan with a fixed interest rate. Fixed rates provide some degree of predictability. Because your interest rate is locked in, you know precisely how much you’ll have to pay each month. This allows you to budget for other expenses. You also benefit in low-interest-rate environments because you lock in your rate for the life of the debt.

Bottom Line

If you’ve ever taken out a loan, you know you can’t avoid paying interest. But understanding how they work can certainly help you save some money. They come in many different shapes and sizes, including fixed interest rates. This type of interest rate is locked in for the entire life of your debt, whether a car loan, line of credit, or mortgage. Unlike variable rates, which change according to the interest rate environment, you’ll know how much you have to pay each month, and your interest rate will never change until you either pay off the debt or refinance.

Conclusion

• A fixed interest rate avoids the risk of a mortgage or loan payment significantly increasing over time.
• Fixed interest rates can be higher than variable rates.
• Borrowers are more likely to opt for fixed-rate loans at low interest rates.