The Definition of Fixed Interest Rates

Control the rate to keep payments lower.

An interest rate is the percentage a lender charges to loan money to a borrower. If an interest rate is fixed, the percentage will stay the same until the loan is paid off. On the other hand, if an interest rate is variable or adjustable, the rate can change during the loan period. Borrowers need to understand the difference before signing for a loan.

Fixed vs. Variable

A fixed interest rate is predetermined. While the amounts designated for interest and principal change during the course of the loan, the payment amount stays the same.

A variable or adjusted rate, however, is readjusted at preset intervals. The interest rate may be lower than a comparable fixed rate loan at the outset but increase during the term of the loan. The adjustments are determined by a specific index, such as the interest rate on Treasury bills. There may be limits to the increase, called the cap, and the amount in addition to the index, known as the margin. An adjustable rate loan also specifies a limit for the interest rate, known as the ceiling. Payments for a variable or adjustable rate loan can vary over the course of the loan.

Mortgages

Borrowers will find several options for a fixed-rate mortgage, a loan secured by the property the loan is used to purchase. A standard fixed-rate mortgage is paid in equal monthly payments usually over a term of 15, 20 or 30 years. Another type of fixed-rate loan is the interest-only loan. At the beginning of the term of this type of loan, the payments are lower and cover only the interest, not the principal. Payments increase substantially during the second phase of the loan when the principal begins to be paid as well the interest. Some lenders also offer bi-weekly mortgages as an option to a monthly payment plan.

Credit Cards

Many credit card issuers began replacing fixed-rate credit cards with variable interest rate cards after the passage of the Credit CARD Act of 2009. Because of new restrictions on card issuers' ability to raise the fixed rate, credit card companies are switching many cards to variable rates that will allow them to raise rates more readily.

Advantages

The website of Freddie Mac, a mortgage corporation chartered by the U.S. Congress, lists three major benefits of a fixed-rate loan. One is protection against rising interest rates. A fixed interest rate means that the payment stays the same and is not affected by inflation. A second benefit is the stability it provides for long-term planning. With a stable payment, it is easier to plan for other parts of your budget. A third advantage is reduced risk. Rising interest rates will not affect a fixed-rate interest loan.

Disadvantages

For some borrowers and some situations, a fixed-rate loan may be disadvantageous when compared to a variable-rate loan. Lower initial payments can make it easier for a borrower to qualify for a larger loan. When interest rates fall, the rate on a fixed-rate loan does not fall with them as it does with a variable rate.

References

• Freddie Mac: Fixed-Rate Mortgages
• Credit Cards: Variable Interest Rate Cards Replacing Fixed Rates
• Investopedia: Mortgages--Fixed-Rate Versus Adjustable-Rate