Fixed Rate Mortgage

Whether it’s realized or not, a fixed rate mortgage is the initial way most people consider financing when they are buying a house.

Since most of us need to finance the majority of the cost, we apply to a bank or other lender for a mortgage loan.  Based on a number of qualifications including your financial profile (I discussed this in an earlier post) and the value of the property, the lender pays for the property and terms of repayment are established.  — For the duration of the loan the lender will hold title deed to your property as collateral (security) against payment default.

The amount of money lent is called principle.  The length of time you have to repay the principle is set when the loan is issued.  (It’s usually 15 or 30 years and payments are most likely to be made monthly.)  You will repay the principle in increasing increments.  This may sound odd since I’m talking about a loan called a fixed rate mortgage, but “rate” is not a reference to speed.  Rather, the percent of interest you are charged is fixed (set) for the duration of the loan.  (Your interest rate will be lower if you take a 15-year mortgage.  —Lenders feel the risk of default increases with the longer 30-year term.)

Interest is the lender’s compensation for making the loan and payments are set up so that your first payments are almost entirely interest; very little of your initial payments go against the principle.  Over time, however, small increments of repaid principle add up, leaving less of a balance on which to charge interest.  Slowly, your payments will change from being primarily interest to mostly principle.  And, since the financial experts know the schedule at which this happens, they can set the dollar amount of your mortgage payment at a constant.

(Note:  Even though your mortgage payment remains the same, there are some other costs—like insurance—that are bundled with your monthly payment.  These additional obligations may cause your total housing payment to vary slightly over duration of the loan.)

As you pay off the principle of your loan (the money you owe), you accrue equity (monetary worth; money you can use) in your property.  During inflationary times your equity value can increase quickly.  This means that the financial impact of the interest you pay on your fixed rate mortgage decreases.  Of course, when the general economy falls (and therefore, property values) your interest will cost you more in relation to the worth of your equity.  Nevertheless, because of its consistency and because it facilitates budgeting, a fixed rate mortgage is attractive to many home buyers.