A fixed rate mortgage, or FRM, is probably the most simple and easy to understand type of mortgage. It is also by far the most popular mortgage type.
As the name implies, a fixed rate mortgage has a fixed interest rate for the term of the loan. The amount of the borrower's payment for principal and interest also remains the same for the term of the loan. At the beginning of the loan term, most of the payment is for interest and only a very small amount goes toward paying off principal. Over time, the amount of the payment that goes toward interest reduces, and and the amount applied toward the principal increases until at term the loan is fully paid off (referred to as fully amortized).
It is important to note that although the principal and interest payment remains the same for the life of the loan, it is possible for the amount that the borrower pays the lender to increase. This is because many borrowers also pay an escrow amount for taxes and insurance to their lender. Taxes and home owner's insurance typically go up over time. So in this case, the borrowers payment for principal, interest, taxes, and insurance (often referred to as PITI) will go up because of increases in the escrow payments. Typically, these increases are modest and fairly predictable.
Conforming and Nonconforming Fixed Rate Mortgages
Fixed rate mortgages may either be conforming, or non-conforming (also referred to as "jumbo"). A conforming mortgage is a mortgage whose loan amount is less than or equal to the loan limits set by the Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac). As of 2006 these limits are:
Please note: The loan limits for 1 to 4 family loans in Alaska, Hawaii, Guam, and the U.S. Virgin Islands are 50 percent higher.
A jumbo or nonconforming fixed rate mortgage is an FRM that is over these amounts.
Fixed Rate Mortgage Term
Fixed rate mortgages have a term, or the amount of time that it takes for the loan to be paid off (referred to as amortization). The most common terms for fixed rate mortgages are 15 and 30 years. Other terms, such as 10, 20 or even 40 years are also not uncommon. Typically, shorter terms have lower interest rates and higher monthly payments of principal and interest because the borrower is paying off the loan over a shorter time frame. The reverse is true for longer term fixed rate mortgages. They typically have higher interest rates but lower monthly principal and interest payments.
Fixed Rate Mortgage Points
Many advertisements for fixed rate mortgages will quote an interest rate and points. A point is equal to 1% of a loan's value (for example, for a $100,000 loan, 1 point would equal $1,000). Generally, the more points on a loan the lower the interest rate (for example, one loan may have an interest rate of 6.25% with 1 point, while another may be 6% with 2 points). In essence, points buy down the interest rate and may be thought of as prepaid interest (which is why points are included in the annual percentage rate or APR calculation that should also be present in all mortgage rate advertisements). Mortgages are available with no points, and typically a higher interest rate.
Fixed Rate Mortgage Options
There can also be numerous other "options" available for fixed rate mortgages which can introduce complexity. Some of the more prevalent options include:
Fixed Rate Mortgage Terms and Conditions
It is important for the mortgage consumer to be aware of some of the terms and conditions of fixed rate (and potentially other types of) mortgages. All mortgages have a "due on sale" clause, meaning that the loan comes due and must be paid off if the house is sold. Some mortgages may also have a "demand clause" which allows the lender to demand full repayment for any reason.
Another feature of some fixed rate mortgages is a prepayment penalty. A prepayment penalty is a cash penalty that you pay if you payoff the entire loan early. Prepayment penalties can be "hard", meaning that the penalty must be paid if the loan is paid off early for any reason including the sale of the home. There are also "soft" prepayment penalties where the penalty applies only to loans paid off by refinancing. Prepayment penalties typically decline over time and usually no longer apply after a loan is five years old. Many prepayment penalties still allow for partial prepayments.
It is important for the mortgage consumer to understand if these features are present in the loans they are considering. Consumers should ask if there is any prepayment penalty for the loan that they are considering, or if there is any clause for repayment other than the "due on sale" clause.