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Fixed Rate Mortgage

Understanding Fixed Rate Mortgage

Fixed Rate Mortgage

Fixed Rate Mortgage (FRM) is a mortgage loan in which interest rate remains fixed throughout the life of the loan. FRM is the most popular loan product and is used as a benchmark against which all type of loans are evaluated.

An FRM loan may contain features such as Interest Only option or Balloon Payment option.

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Fixed Rate Mortgage Loan Products

Typical fixed rate mortgage loan products are:

  1. 40 Year Fixed: FRM having a loan term of 40 years. Because of the way amortization works, this loan should be obtained only in cases of very low interest rates, such as less than 5%. This is because, the slight reduction in payments, as compared to 30 Year mortgage, is a very small advantage as opposed to the large increase in total payments.
  2. 30 Year Fixed: FRM having a loan term of 30 years. This is the most common mortgage loan in USA and is usually a first lien loan.
  3. 20 Year Fixed: FRM having a loan term of 20 years.
  4. 15 Year Fixed: FRM having a loan term of 15 years. After the 30 year FRM the 15 year FRM is the most common loan in the US. Suitable for borrowers with a low loan amount, or those that to aggressively pay off their mortgage loan.
  5. 10 Year Fixed: FRM having a loan term of 10 years.
  6. 30 Due in 15 Balloon: 30 Due in 15 Balloon is a FRM having a loan term of 15 years but an amortization term of 30 years. Therefore, the loan would carry a large balloon payment at the end of the 15 years.
Source :www.MortgagesAnalyzed.com

Benefits to the Borrower

  1. No interest rate risk: The borrower is protected against any increases in interest rates and inflation. The flip side is, obviously, that the borrower will not be able to take advantage of decrease in interest rates. However, there is the option to refinance when rates falls.
  2. Predictable payments: There is predictability in the periodic payments, which will allow the borrower to perform long term planning and budgeting.
  3. Low risk: There is no guesswork in determining the monthly payments and the security of knowing the rate and payments reduces risk in missing payments.
Source :www.MortgagesAnalyzed.com

Considerations for the Borrower

  1. The fixed rate mortgages are usually at a higher interest rate than adjustable rate loans. This is to compensate the lender for the interest rate risk. The higher cost may mean a lower amount that a borrower would qualify for.
  2. Fixed rate mortgages are more suited for borrowers that intend to occupy the property for a long time (more than 10 years), first time home buyers, borrowers with fixed income, and those seeking a low risk mortgage.
  3. FRM's may be an ideal loan when interest rates are low and the expectation is for the rates to increase. Note that this not a recommendation that a borrower try to time the market. Instead, the borrower should try to evaluate the current business cycle and market expectations for changes in interest rates in the future.
  4. If the borrower expects to occupy the real estate for short term, such as 5 or 10 years, then the borrower should consider Hybrid ARM’s as a low cost alternative. This will provide the stability in the initial term, which should matches the expected term of occupancy, and offer lower interest rates.
  5. While the interest rates will remain fixed, the monthly payment may fluctuate. This may be due to other options attached to the loan such as interest only option, mortgage insurance, etc. The borrower should carefully understand the elements of monthly payment.
Source :www.MortgagesAnalyzed.com

Benefits to the Lender

  1. Enhanced returns during increasing interest rate: In the event of declining interest rates, the lender can enjoy enhanced returns on its fixed loan portfolio. However, such gains are generally short lived as the borrowers will try to take advantage of low rates by refinancing their loans to lower interest rates. In such scenario, lender may want to redirect the refinance business to itself by proactively offering low interest rate on its loans.
Source :www.MortgagesAnalyzed.com

Considerations for the Lender

  1. Interest Rate Risk: In periods of increasing interest rates in the market, the fixed rate mortgages may exposure the lender to undue interest rate risk in the form of declining value of its fixed rate loan portfolio. Furthermore, if the bank relies on short terms financing for its loan portfolio, then it may face liquidity issues as the payment stream from the fixed rate mortgages may be less than the interest charges of the short term sources of finance.

Updated: Jul 07, 2010

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