Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Fixed Interest Rate

What it is:

A fixed interest rate is a type of loan or mortgage for which the rate of interest does not fluctuate over the life of the loan.

How it works (Example):

The most common types of mortgages carry either a fixed or variable interest rate. While the variable rate can change over time, the fixed rate is set usually as a given amount above the 30 year Treasury bond rate at the time of setting. 

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:

The choice between fixed and variable rates depends on both personal factors such as the borrower's family and employment status, and market factors such as the interest rate climate.

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.