Fixed Interest Rate
What it is:
How it works (Example):
The benefit of a fixed interest rate loan or mortgage is the stability of the payment over a period of time. In the case of home mortgages, this is usually a 30-year period. In this scenario, the borrower can budget his payments without worrying what the future interest rate market will be. Most of the initial payments go toward interest on the loan and only a small portion reduces the principal of the loan. As the principal is reduced the corresponding interest charge is reduced, thus enabling more of the payment to reduce the principal. This process takes place for 30 years until the last payment consists entirely of principal and no interest
A disadvantage is that fixed rate interest is usually higher than the variable rate.
Why it Matters:
A borrower may opt for a fixed interest rate if he is concerned that rates will be going up and if he is a more risk-averse investor.